Buying a car is expensive, so it’s important that you get the right car, the best deal and the most affordable loan. When borrowing money for a purchase, the choices you make need to be thought out and planned—never impulsive. Here’s what you need to know before getting an auto loan.

The Five Cs of Credit

The five Cs of credit is a type of checklist that lenders use to gauge a borrower’s creditworthiness. It weighs five characteristics of the borrower and conditions of the loan, in attempt to estimate the chance of default. Default refers to the borrower’s failure to pay interest or principal on a loan when it’s due.


Character

Character is also referred to as credit history, which gives the lender an idea of the borrower’s history in regards to repaying debt.


Capacity

Capacity assesses the borrower's debt-to-income (DTI) ratio. This means how much debt you have versus how much income you have coming in. In addition, job history is also examined to see how long the borrower has been at their current place of employment.


Capital

Capital refers to the down payment you put toward your purchase. Down payments can show the borrower's level of seriousness and dependability, which can help make lenders more comfortable.


Collateral

If a borrower was to stop making their payments, collateral may be needed in order to give the lender assurance that they can repossess the purchase. In the case of an auto loan, the car would be the collateral.


Conditions

The conditions of the loan, such as the amount of principal and its interest rate, can help influence the lender's chances to finance the borrower. Specific conditions refer to how a borrower intends to use the money, such as using a vehicle solely for school or work.


Should I Finance My Car Loan With a Dealership or My Bank?

Dealer Financing

Although good rates through dealerships aren’t unheard of—proceed with caution. Some dealerships make a commission off of loans that they sell, so don't feel pressured into getting a loan that’s not right for you.


First, ask them who the lender is. Make sure they are a reputable company to ensure that you won’t have problems in the future. Also, check customer reviews to see what others have to say about their experience.


Second, check the interest rate that you are being offered. Sometimes dealerships do offer deals on interest rates when they’re trying to push inventory, but many of these offers are only available for people who have a 750+ credit score. If you don’t have an exceptionally high credit score, they may charge you a high interest rate, upwards of 7%, so you’d actually be spending more money in the long run.

Bank or Credit Union Financing

There are several benefits of obtaining a loan from your bank or credit union. First is ease. You can apply for an auto loan and get a pre-approval letter before you even step foot inside a showroom. This will let you know how much you can afford and will prevent disappointment if you pick out a car you aren’t able to get approved for.


Sometimes, banks or credit unions can negotiate a lower interest rate, which means that you will pay less for the car in the long run. If you have other banking services through your chosen bank or credit union, such as a mortgage, this can also help lower your interest rate.


But wait, we haven’t covered all the benefits yet! When you use your bank or credit union for auto financing, you can add your loan to your online account, and easily make your payment each month. You can even schedule recurring payments so you never forget!


No matter who you choose to finance your car through, always research your options. The best place to obtain a loan is nearly always your bank or credit union.

Loan Length

An auto loan typically has a length of 36 to 84 months. A longer-term loan typically has a lower monthly payment than a shorter-term loan, but you end up paying more in the long run over the life of a longer-term loan. For example, you might have a $300 monthly payment on a 36-month loan or a $150 payment on a 60-month loan, but the 60-month loan will cost you more in interest.


Generally, you will be able to choose how long you’d like to finance your car for. Keep this in mind, and choose what will work best for you now, and in the future.

Payments

An auto loan’s monthly payment is typically fixed for the life of the loan. A fixed loan means that the payment won’t fluctuate, which is an important factor to make sure of before you sign any paperwork.


A portion of each payment will go toward interest and reducing the loan’s principal balance. As you make each payment, the portion that is applied to principal increases, which means you pay the loan off faster toward the end than toward the beginning. For example, $100 out of a $200 payment might go toward principal at the beginning of a loan, while $175 might go toward principal at the end.


An auto loan is a type of secured loan, which means that the car you buy is collateral for the loan. If you fail to make payments, your car may be repossessed. Make sure you do the necessary research before deciding on such a big purchase.