When Is the Best Time to Apply for an Auto Loan?

Consumer affairs expert Kathryn Morrison of South Dakota State University explains the process of buying a car, which involves finding the car and taking out a loan to pay for it. She aims to help would-be car buyers understand the confusing world of automobile loans and avoid getting taken for a ride. Dr. Morrison’s conversation with Investopedia provides valuable insights into car loan complexities.

Differences between auto loans and personal loans

Investopedia : Auto loans differ from other consumer loans like personal loans in several ways.

Morrison: An auto loan requires collateral, which is the value of the vehicle, as security for the lender. The lender has protection against default, meaning if the borrower fails to make payments or defaults, the bank can seize the underlying asset.

Auto loans are secured loans used to purchase a vehicle, unlike personal loans that can be used for various purposes. This results in lower interest rates as the lender takes less risk, as they can seize the vehicle to cover the unpaid loan if needed.

Car loans are fixed-period loans, with repayments over a specific period, often three, four, or five years, and some consumer loans allow for a specific payback period.

Investopedia: The question asks if pre-owned car loans differ from new car loans and if so, how.

Morrison: Consumers should compare auto loans from various lenders, regardless of the vehicle’s condition, as loan terms depend on the vehicle’s price and available interest rates.

New vehicles typically have lower borrowing rates compared to pre-owned ones due to their higher cost. However, some manufacturers offer low or even 0% financing options, resulting in lower rates on new vehicles.

Dealerships offer various financing options, with rates and terms varying based on factors like new vs pre-owned vehicles. Therefore, it’s advisable to explore multiple financing options before making a vehicle purchase. When Is the Best Time to Apply for an Auto Loan?

Lease or Buy

Investopedia: The question is whether a lease and a loan are the same and if so, how they differ.

Morrison: Leases and loans are distinct entities. Leases involve ownership of a vehicle and periodic payments against the loan balance, while loans allow you to own the vehicle title-free and clear upon repayment.

Leases involve renting a vehicle for a specified term under specific conditions, with the option to return the vehicle or pay residual value at the end. This makes monthly payments usually lower than auto loans. However, careful consideration of lease terms, such as maximum mileage and whether to purchase the vehicle at the end of the term is crucial.

Comprehensive guide on how to prepare to borrow

Investopedia : Before shopping for a car loan, it is essential for a car buyer to gather the following information,

Morrison : Before purchasing a vehicle, conduct thorough research and choose the appropriate model. Utilize an online vehicle ranking tool to compare reviews and ratings, ensuring the vehicle meets your needs and ranks high in crucial areas like safety, gas mileage, and price.

Before visiting a dealership, narrow your options by considering your financial capabilities and the amount of cash you can or should put down. Utilize a lease versus purchase calculator to determine the best option.

To find the best auto loan, compare rates from various lenders like local banks, credit unions, insurance companies, and online lenders. To understand your credit score and its impact on rates, check your credit history from AnnualCreditReport.com, one of the three free credit reporting companies.

To improve your credit history, fix any errors and visit a dealership to review their rates and terms. Compare loan options and be open to discussing available rates with the dealership to see if they can beat them.

Before applying for a loan, research vehicle ownership costs, obtain auto insurance quotes from multiple companies, and consider annual gas and maintenance expenses from gas and maintenance costs.

Monthly car payments are a crucial aspect of financial management

Investopedia: Is there a general rule for determining the appropriate car payment amount?

Morrison: Individuals have unique financial needs, and there is no universally accepted rule for car payment. While some suggest vehicle costs should be below 20% of net income, more factors should be considered.

Consider your other debts, repayment schedules, income, emergency fund, and monthly expenses. Determine if you have a steady income to repay the loan and have an emergency fund for unexpected expenses. Keep in mind that adding the loan payment will impact your overall budget, so avoid overextending yourself.

GAP Insurance Pros and Cons

Investopedia: GAP insurance is a type of insurance that provides coverage for property damage caused by natural disasters.

Morrison : New vehicle depreciates from 10% to 30% within the first year, and GAP insurance is designed to cover the difference between the loan amount and the current, depreciated vehicle’s worth, as the vehicle loses value upon delivery.

For example, if you buy a new vehicle and finance all of it at $30,000 and get in an accident one year later, you may owe more on the vehicle than it is now worth after depreciation. A standard auto policy will cover the damaged auto at its current replacement value, but the GAP insurance will then cover the difference between that replacement value and what you still owe on the vehicle.

GAP insurance is essential for leased vehicles and when buying a vehicle with little or no money down. It is also used when a consumer trades in a financed vehicle with negative equity. Auto insurance companies often charge less for GAP policies than dealerships, so it’s recommended to get multiple rate quotes before purchasing at a dealership.

Extended Warranties

Investopedia: Discusses the concept of extended warranties, undercoating, and other financial options.

Morrison: Dealerships often offer extended warranties and added vehicle protections, which vary by person and situation. Extended warranties spread the cost of repairs over the term of the warranty, allowing customers to pay a smaller monthly payment instead of paying for the full repair when it occurs.

Consumers should negotiate warranty prices, as listed prices may be higher than what salespeople or financing officers can offer. Be patient and shop around, as an extended warranty can be added later.

Rust prevention, leather and fabric protection, undercoating, and other dealer options are available. These services may not be necessary, but consider your situation and value. Be sure to understand the product and the price charged for the service, as it may not be necessary for your needs.