Whether you’re looking for a sports car or need to purchase a new family mini-van, vehicles can be expensive. You’ll likely decide to take out a loan to purchase one, so use this quick guide to help you understand which type of loan fits your needs.
Secured vs. Unsecured Loans
A secured loan is the most common type of loan. Typically, the terms of the loan are written into the car’s title. This means if the borrower stops making payments, the lender can take the vehicle. However, sometimes the lender puts the lien on a car or home the borrower already owns. Some finance companies offer unsecured loans. Unsecured loans are usually only available to people who have good credit scores or a substantial income. However, unsecured loans also expose the lenders to more risk, so expect to pay a higher interest rate if you obtain this type of loan.
Pre-Computed Interest vs. Simple Interest
Pre-computed interest occurs when the lender calculates the total of the interest to be paid for the life of the loan and then divides it by the number of months in the loan term. This way, the borrower pays the same amount of interest on each monthly payment, regardless of the balance of the loan. Pre-computed interest means the borrower must keep paying the interest, even if he or she pays off the loan early. If you intend to pay your loan early, a pre-computed loan is probably not the best choice. Most people don’t use this type of loan anymore.
Simple interest loans are more common. These types of loans base the interest rate on the loan’s outstanding balance. Simple interest is calculated on a periodic basis that was pre-set during the signing of the loan. When a borrower pays more than the minimum monthly payment, he or she will save on the cost of interest. Making early payments allows borrowers to pay off these loans faster and pay less interest over time.
Common Places to Apply for an Auto Loan
Banks, car dealerships, credit unions, and home equity loans are the four most common places to secure an auto loan. The easiest route is usually to find financing through a bank. Both private and commercial banks have a lot of capital and can easily dole out loans. They are an especially good choice if you are looking for the lowest interest rate possible. The loan process is also often faster when going through a bank since they can complete many transactions in a short amount of time.
Most car dealerships also provide financing to boost their sales. They usually do so through established relationships with banks or other lenders. While this can help you get a loan quickly without doing a lot of the work yourself, remember that dealerships usually profit from the loans they provide, so expect to pay higher interest rates and read the contract carefully for other terms and fees.
Credit unions work much like banks but are non-profit organizations. The upside is that their interest rates are more competitive, but the downside is that you must be a member of a credit union to reap its benefits. Credit unions usually focus on people who live in a specific area, belong to a certain group, or work in a certain area, although specific requirements vary depending on the union.
Finally, some people use a home equity loan. This alternative loan allows banks, credit unions, or other financial institutions to lend money based on the borrower’s home value. A home equity loan can be used for various reasons, but many people choose to use them to purchase a vehicle. One of the biggest benefits of a home equity loan is that the borrower can usually deduct any paid interest on his or her tax returns.
Other Things to Consider
Now that you understand the basics, consider these tips for auto loans. If your need for a car isn’t urgent and you have a low credit score, first work to pay off old debt and build your credit score. Getting a low-interest credit card and paying the full payment each month can help you to build credit if you don’t have any yet. Save as much money as you can to go toward your new car purchase as well. The more money you save, the less you’ll need to borrow and pay interest on.
Above all else, make sure you thoroughly read your contract before signing on the dotted line for a loan. Doing so will keep you from being surprised by fees or other terms. Happy car hunting!
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