How Do Auto Loans Work?

If you’re buying a vehicle for the first time, or you’ve only purchased vehicles with cash in the past, you might have questions about how the auto loan process works, including the application process, repayment, and how to secure the best possible deal.

An auto loan can be a great financial tool to help you afford the car you want and need while improving your own financial stability. But if you want to maximize the value of this financing, you need to understand the factors that affect your interest rate and the overall cost of your vehicle.

With that in mind, here’s a quick dive into how auto loans work and how you can use this financial product to improve your financial stability and the long-term value of your vehicle purchase.

The Basics of Auto Financing

Auto loans operate similarly to any other type of consumer loan: Borrowers seek out this financing by filling out an application with a lender, providing income and other relevant financial information, and waiting for approval from the lender on that loan.

One key difference between auto loans and other types of loans, such as mortgages, is that the time frame for these approvals is much faster, sometimes taking place on the same day as the initial application. Faster approvals are facilitated by several different factors, including the ability to place a lien on the vehicle being purchased.

If you acquire financing through a dealership, this financing is also part of a larger package of services that increases the total earnings of the dealership. Dealership financing can also potentially serve as a tool for incentivizing buyers with promotions.

Why Auto Loans Are So Affordable

As you compare rates from different lenders, you may notice that auto loan rates are lower than most other consumer loans you may seek out to afford large purchases. The main reason for this affordability is that the vehicles offer a convenient form of collateral: Lenders can offer low rates because, in the event a borrower doesn’t repay the loan, a lender can repossess the vehicle.

Auto loan terms are also much shorter than many other types of loans, which makes them less risky and thus supports a lower rate. And, as mentioned above, in cases in which dealers provide financing promotions to make a purchase more affordable or attractive, the financing itself can be a marketing tool as much as its own form of profit for that dealer.

How to Get the Best Auto Loan Possible

When it comes to financing a vehicle, buyers will be rewarded for putting in a little elbow grease to find the best rate and position themselves to pay as little interest as possible. Whether you’re financing a vehicle for the first time or simply looking for ways to score a better rate and deal on your next purchases, here are some tips to maximize the value of your next auto loan:

Pull your credit report before applying for a loan.

Make sure your credit report is in good shape. Check for any errors in reporting, and consider taking small steps to improve your credit score, such as paying off credit card debt to reduce your overall debt utilization.

Shop around for competitive loan rates.

Don’t settle for the rate offered by a single lender—especially if that lender is on the dealership lot. Request rate quotes from several lenders, including a local community bank.

Choose your repayment term rates. 

Longer repayment terms may come with higher interest rates on the loan. By committing to a shorter repayment term—assuming you’re able to make the monthly payment—you may be able to push your interest rate even lower.

Check with dealerships about financing offers.

Used vehicles typically don’t come with promotional rates, but new car purchases could offer high-value promotions such as low introductory interest rates or even zero-percent financing if you pay off the vehicle within a certain period of time.

Auto loans are relatively straightforward, and these small tips and tricks can help you shave down your interest rate and avoid any hazards in the approval process.

Looking for help polishing up that credit score and paying down other consumer debt? Download The Definitive Guide to Paying off Credit Card Debt today.