How do Car Loans Work? Auto Loan Finance Department

Now that you found the vehicle that fits your and your family's needs the next step is paying for the vehicle.  Often this consist of getting an auto loan, but how does an auto loan work?  Below is everything you need to know about an auto loan and the language you'll hear associated with it.

In simple terms an auto loan works by providing you a lump sum of money, through a lending institutions, for you to buy a car.  You'll repay the loan through previous agreed to terms by making monthly payments (including interest) over the number of months your lender has given you to pay the money back.  The lender will put a lien on the title to the car until the loan is fully paid back, and can repossess the vehicle if you fall behind on your monthly payment obligation.

Let's start at the beginning of the loan process and go from there.

Credit Application Process


To get a car loan you will start by applying for a loan with a lender.  Lenders consist of banks, credit unions, online lenders, or even at the dealership you are purchasing the car from.  Most lenders will make it convenient for you to apply for a loan simply by filling out an application online through their website. It is always a good idea to compare your loan terms through a few different lenders to make sure your getting the best terms possible.  Most dealers have relationships with multiple lenders and are able to submit applications to a few different lenders at once.  This saves you time filling out multiple applications and is a good way to compare multiple lenders quickly.

Information Needed to Apply for a Loan:

  • Social Security Number
  • Current and Past Address (Length of time you lived at both)
  • Current and Past Employment Information
  • Total Income and Income Sources
  • Information on any other Debt you may have

Getting Approved for a Car Loan


During the approval process you may be asked to provide some information or documents to the lender.  These are used by the lender to verify some of the information uou provided them, or are needed to allow you to complete your purchase and drive off in the car.  The below items are referred to as stips (short for stipulations), and may or not be asked for when having a car loan approved.

  • Proof of Income:  Pay stubs or bank account information used to verify your monthly income
  • Proof of Residence:  Usually a Utility bill you receive at the current address you provided.  Many lenders have also started using Cel Phone Bills.
  • Proof of Insurance:  Full coverage insurance will be required for any vehicle you are purchasing that is being financed.
  • References

Getting approved for a loan will start with checking your credit score and credit history.  If you don't have a vehicle selected yet it also may begin with a pre-approval.  Be aware though that the terms and approval may differ from your pre-approval once a full appication is filled out with your vehicle os interest.


Important Key Terms to Know When Getting a Loan

  • Monthly Payment:  Amount due each month per your loan agreement.  The payment is made up of principal and interest.
  • Annual Percentage Rate:  (APR) Amount you pay each year to borrow money for the auto loan.  This includes any lenders fees.  The APR is expressed as a yearly percentage.
  • Total Cost:  The full loan amount including Principal, Interest, Down Payment, and any Lenders Fees.
  • Loan-to-Value Ratio:  (LTV) The value of the car you are purchasing compared to the loan amount.  Lenders secure auto loans using the vehicle as collateral, so the LTV is a way for the lender to measure their own risk when approving a loan. LTV can also affect your loan rate and whether you are approved for a loan or not.
    • Principal Amount:  Amount agreed to pay for the vehicle you are purchasing.  This amount does not include interest, fees, or other cost.
    • Down Payment:  This is an amount you pay up-front for a loan.  You can make a down payment in cash or use positive equity from a trade-in as down payment.  Making a down payment helps to lower your monthly payments, and lenders also see it as an initial investment by the buyer that can help with loan approval and more favorable loan terms.
    • Interest Rate:  Rate the lender charges for the money being loaned.  Does not include loan fees.
    • Loan Term:  Also referred to as loan duration.  The length of time you have to pay your loan back.  Loan terms are generally in 12-month increments (24, 36, 48, etc.)  It is recommended to use the shortest loan term you financially can in order to pay a smaller amount of interest.

    What Car Loan is Best For You


    Once you have a car picked out and have been approved for a loan a lender will present you with several different options for setting your loan up.  You'll see different Loan Terms, Down Payments, Interest Rates, and Monthly Payments.  Your first inclination may be to go with the lowest monthy payments, but that may not be the best choice.  That monthly payment may be at 60 months when your budget affords the monthly payment at 36 months, and while that 60 month payment looks very tempting you could end up spending more money over that time period when you include interest than you would at 36 months.  Lets look at the below example to get a better picture of what we are talking about.

    Let's say you are getting a loan for $20,000 at 3.75%.  This interest rate is good across a few different Loan Terms (60 months and 36 months).You'll notice the difference in monthly payment, and if that's all you look at the 60 month term looks like the way to go, but once you look at the Total Cost you realize the difference and why you spend less money financing your vehicle for 36 months.

    Loan Term Mothly Payment Total Interest Paid Total Cost
    3 years (36 Months) $588 $1,177 $22,345
    5 years (60 Months) $366 $1,965 $23,925

      So, even thouh taking the loan term of 60 months lowers your monthly cost by $222, you end up paying $788 more in interest over th elife of the loan, and $1,580 more in total.  As long as the monthly payments fit in your budget it's always a good idea to finance your vehicle for the shortest term possible to reduce your Total Cost of the loan.

    In Conclusion


    It's important to understand how car loans work before purchasing a vehicle, which is often the second biggest purchase people make in their lives.  Always be sure to compare Loans and Terms from different lenders to make sure your getting the best financing possible for your budget and situation.

    OKC Auto Direct  

    5600 S. Shields Blvd
    Oklahoma City, OK 73129
    Phone (405)724-9147

    Store Hours

    Monday:9:00 AM - 6:00 PM
    Tuesday:9:00 AM - 6:00 PM
    Wednesday:9:00 AM - 6:00 PM
    Thursday:9:00 AM - 6:00 PM
    Friday:9:00 AM - 6:00 PM
    Saturday:9:00 AM - 6:00 PM

    OKC Auto Direct