Loan Options for Autos: Understanding the Types of Car Loans Available

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If you’re looking to purchase a vehicle, there’s a good chance that you may need to take out an auto loan to help pay for it. So, where do you start? There are plenty of loan options for autos, and the financing option you choose can have an impact on the amount you end up paying over time. 

It’s important to understand your options for auto loans to make sure you select the best financing for you.

How Do Auto Loans Work?

An auto loan is a type of financing specifically used to purchase a vehicle. Rather than paying the full price upfront, the borrower agrees to repay the loan over time, typically in monthly installments that include both principal and interest.

Here are some key points to know:

• Most lenders offer auto loans in terms ranging from about two years to seven years, although you can find both shorter and longer options available.
• Interest rates can vary significantly based on the lender and your credit history.
• The size of the loan, interest rate and the term length will determine your monthly payment amount.
• A good or excellent credit score usually opens the door to lower rates and more flexible terms, and it can end up trimming thousands of dollars off the cost of your loan.

Good To Know

The average monthly payment for a new car loan is $742, while used car loans average $525 per month, according to Experian.

Keeping these figures in mind can help you budget before you shop.

Types of Auto Loans

Here’s a look at the different types of auto loans available and the borrowers who can benefit from each.

New Car Loans

• These loans are for those buying brand-new vehicles from dealerships.
• Lenders often offer lower interest rates on loans for new cars because they can more accurately assess the value of a vehicle.
• Automakers also may offer attractive rates to entice customers to buy their vehicles.
• You can get new car loans from banks, credit unions and online lenders.

Used Car Loans

• Designed for those looking to finance the purchase of a pre-owned vehicle, used car loans typically have higher interest rates.
• Increased rates are due to the depreciated value of the car and the greater risk taken on by lenders.
• Banks, credit unions and online lenders offer used car loans.
• Some dealerships will arrange financing through third-party lenders or their own programs.

Auto Loan Refinancing

• Auto-loan refinancing allows borrowers to replace their existing car loan with a new one that usually offers a more attractive interest rate or term.
• Some people may refinance a car loan to cut down on the overall amount of interest payments, while others may extend their terms to create more manageable monthly payments.
• Auto-loan refinancing can be a good option for those who have improved their credit score since they got their initial loan.
• You may also want to refinance if interest rates have dropped.

Lease Buyout Loans

• These loans help you buy a car you’ve been leasing.
• When the lease term is up, you can use this loan to pay off the car’s value.
• These can typically be arranged through the dealership you’re leasing from or through a bank, credit union or online lender.

Balloon Payment Auto Loans

• This type of car loan allows you to make lower monthly payments during the term of the loan.
• With this loan, you’ll owe a large lump sum at the end of the term to pay it off.
• Dealerships often offer this type of loan to customers who are searching for low monthly payments.
• While balloon-payment auto loans can be risky for the borrower, they can be a good option for those who plan to refinance or sell the car before the final payment is due.

Buy Here, Pay Here Loans

• These loans are offered by dealerships and are targeted toward buyers with poor credit.
• They usually come with higher interest rates and they may require more frequent payments.
• While these loans typically end up costing you more in interest, they can be a last-resort option if you’ve been turned down by other lenders.

Secured vs. Unsecured Auto Loans

When shopping for car financing, you may come across two general types of loans: secured and unsecured.

• Secured car loans: These loans are the most common type. It uses the vehicle as collateral, meaning the lender can repossess the car if you miss payments.
• Unsecured car loans: These don’t require collateral, but they often come with higher interest rates because the lender takes on more risk.

Where To Get an Auto Loan

You’ve got plenty of choices when it comes to auto loans. Here’s where to start your search.

Banks and Credit Unions

Offering competitive interest rates and flexible terms, banks and credit unions hand out the most auto loans annually.

These institutions will need to pre-approve you for a loan, and you need to have a strong credit score for favorable terms.

However, getting pre-approved can give you a negotiating advantage when it comes time to ask the dealership about financing rates. You may be able to use the preapproval to get an even better rate from the dealer or manufacturer. 

Online Lenders

Those looking for a fast and easy way to apply for auto loans may find online lenders to be an appealing option. You’ll typically get a quick decision on your application and many online lenders have rates that compare favorably with other financing options.

Most online lenders have user-friendly digital tools that allow you to compare options based on your financial situation and credit score.

If you’re comfortable researching online and you prefer the comfort and speed that allows, online lenders may be your best option.

Captive Lenders

By far the most common way people finance a new-car purchase is through what are known as captive lenders. These lenders are owned and run by the auto manufacturers. Some examples of these are Toyota Financial Services, Ford Credit and GM Financial. 

Captive lenders often run special financing deals to promote sales, such as 0% APR for a period of time. Getting a loan through the manufacturer also makes the process simple, cutting out the step of applying and comparing rates at outside lenders such as banks. 

However, these financing options may be more restrictive, with less flexibility on terms or choice of car model. They can also be less transparent, and the interest rates may ultimately be higher once the promotional rate ends.

Dealership Financing

Many dealerships will set up car loans for you through third-party partners. This is a convenient option for buyers, but it may not result in the best possible interest rate since you’re limited to working with the dealership’s preferred lenders.

Choosing the Right Auto Loan for You

There are several loan options for autos, each suited to different budgets and situations. Here’s a breakdown to help you choose.

Final Thoughts

With so many loan options for autos available, it’s worth taking the time to compare lenders, rates and terms.

You may want to start by comparing the best banks for car loans, and figuring out how much interest you’ll actually pay on your auto loan.

Consider the overall amount you’re willing to pay while also determining what a manageable monthly payment looks like for you.

Stacey Bumpus contributed to the reporting for this article.

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