Types of auto loans: Find which is right for you
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When you’re ready to buy a car or refinance an existing loan, you have a few different financing options.
Each type of auto loan has its own set of pros and cons and specific uses. Some can be used for purchases, while others are only viable if you currently have an auto loan. So it’s important to do your research before you decide which is right for you and your needs.
New car loans
New car loans are used to purchase brand-new cars. You can secure financing through the dealer, but it’s not mandatory. You can often get a better deal by using a traditional bank, credit union or online lender, but dealer financing may make the process more seamless.
In general, you get a loan for a term of three to five years. Some lenders feature loan terms of up to 84 months. Your loan amount, interest rate and repayment period determine your monthly payment — try Bankrate’s auto loan calculator to get an estimate.
Depending on the financing arrangement, you may also be required to make a down payment. Financial experts suggest that you put at least 20 percent down, but it’s best to pay only what you can comfortably afford.
Used car loans
A used car loan is a type of car loan that allows you to finance a used vehicle. They’re available through auto dealers, traditional banks, credit unions and online banks.
Some of the most popular used car loans are for certified pre-owned, or CPO, vehicles that usually come with an extended warranty. But many lenders offer used car loans for cars that are not CPO vehicles.
Used car loans are typically paid back in monthly installments over three to five years. Like new car loans, the monthly payment is based on the financing agreement’s terms. Be mindful that most lenders have restrictions regarding the maximum age and mileage of vehicles eligible for financing.
Auto refinance loans
An auto refinance loan allows you to take out a new loan to replace your current one. You may pursue one if you have a loan with a higher interest rate and want a new loan with a lower interest rate or a longer term.
With a lower rate, you may be able to lower your monthly payment and save money in the long run. A longer term will also lower your monthly payments. However, due to interest, it won’t lower your overall cost.
You’ll need a credit score of 670 or above for the best rates. If your credit is less than ideal, you might consider other options, such as selling your car to pay off your loan.
Cash-out auto refinance loans
A cash-out refinance loan is similar to traditional refinancing. It lets you convert your car’s equity into cash. You’ll replace your current loan with a new one that includes the equity you borrowed.
Typically, the equity you have in your car limits the amount you get back.
A cash-out refinance’s main draw is having more cash at your disposal. You could also secure better financing terms, making your monthly payment more affordable. Still, you will pay more interest, which means you’ll be paying more money over the life of the loan.
Private party auto loans
A private party auto loan is a loan taken out specifically for purchasing a car owned by a private party. Banks, credit unions and online lenders offer this type of loan.
Because the loan is secured by the vehicle, there are limitations on what types of vehicles you can buy. Cars must typically be 10 years old or younger and under 150,000 miles.
Lease buyout loans
A lease buyout is what it sounds like: It’s a car loan that can help you purchase the leased vehicle. You take ownership of the vehicle while the lender allows you to continue making the same monthly payments you made throughout the lease.
You should know the difference between a dealer buyout and a buyback. Dealer buyouts are available when you purchase a car for cash, as you are buying the vehicle from the dealership instead of leasing it. A buyback is when the dealer purchases the leased vehicle from you before the lease is up.
Other auto loan variations
Auto loans also vary based on how interest is computed, how you get the loan and whether the loan is secured by collateral. The above loans can use simple interest or precomputed interest, be secured or unsecured, and be obtained through direct or indirect financing.
Simple interest loans vs. precomputed interest auto loans
Auto loans can have two types of interest: Simple interest loans or precomputed. Simple interest loans are much more common. They calculate the interest paid each month based on the interest rate and current loan balance. Early in your loan term, more of your monthly payment goes toward interest; the balance flips late in your term.
Precomputed interest loans have the loan balance, origination fees and interest calculated at the beginning and divided across the loan term. Both principal and interest payments are the same each month.
If you pay on time for each payment over the entire loan term, there is little difference between the two. However, if you plan to pay the loan off early or make larger payments, a precomputed interest loan will not save you money — since interest for the entire loan term is already factored into the payment amount.
Direct auto financing vs. indirect auto financing
This distinction has to do with how you obtain your loan: By working with a lender directly or by working through a dealership.
Direct financing is when you obtain auto financing through a bank or credit union.
Getting approved or preapproved for an auto loan with a lender before going to a dealership can give you an edge during negotiations. You will receive the amount of the loan and the interest rate. This allows you to shop for a car knowing exactly how much you can spend. The dealer simply verifies the information and completes the transaction. Or, you can use the offer you’ve received to negotiate a better deal on financing with the dealer.
With indirect financing, the dealer offers its own financing through its lending partners. You work with the dealer to fill out your auto loan application, and the dealer sends the application to a lender or lenders. While indirect financing can be convenient, the dealer may mark up the interest rate to ensure they profit.
Secured vs. unsecured auto loans
Secured car loans require providing collateral to the lender — typically the car title. Banks generally offer better interest rates and more flexibility on qualification for secured loans because of the collateral.
Unsecured auto loans are personal loans used to purchase a new or used car. They have higher interest rates and qualification standards due to the lack of collateral. To qualify for an unsecured loan, a borrower needs a solid credit score, a borrowing history that shows a track record of consistent, on-time payments, and a reliable source of income.
The bottom line
Not all auto loans are the same. The option that best suits your financial needs and budget will depend on if you want to buy a new or used car, refinance your current loan to secure more competitive financing terms, or borrow against the equity you have in your vehicle.
Before deciding which type of auto loan is best, do your homework to understand what each has to offer. Also, shop around to find the best lenders and get pre-approved to ensure you score a competitive financing offer.