Let’s take the mystery out of auto loans

For many people, their first lending experience is when purchasing a car. Since few young people have cash on hand for a purchase so large, an auto loan is a way to establish credit while fitting vehicle ownership into the monthly budget. To complicate matters further for first time borrowers, vehicle prices and interest rates are higher than just a few years ago. It’s more important than ever to compare financing options carefully and make the right choice for your situation.

First, get pre-approved

One thing you can do to simplify your car-buying process is to get pre-approved for your loan, keeping in mind the pre-approval is contingent on the vehicle you are hoping to purchase. This is usually a straightforward process at a community bank, and it helps you know your budget before you fall in love with a top-of-the-budget vehicle. If you have your basic financial information ready, such as income, employer details and basic monthly expenses, you should be able to work with a lender to estimate a loan amount or price range to fit your situation. Knowing your price range up front can help you shop with negotiating power. Fit the vehicle to your budget, not your budget to a vehicle.

The down payment

If you’re planning well in advance, you’ll have a down payment saved up before stepping on the car lot. Typically, when seeking a loan, it helps to have a 10-20% down payment. Many lenders require it, and it can make a significant difference in your monthly payment. Saving funds for a car takes discipline, but there are some ways to make it easier. Start by setting up an automatic savings plan, so each month a predetermined amount will be transferred into your savings account. Having a savings plan in place makes fitting that loan repayment into the budget easier, too.

About loan term length

Once you’ve saved for a down payment and established how you will fit a car payment into your budget, it’s important to learn about auto loan term lengths. While car loans used to be paid out in either three or five year terms, the vehicle market and financial environment has changed over the last few years. At The Bank of Missouri, we offer different term options based on the age of the vehicle and its mileage. The older the vehicle, the shorter the term. This helps the borrower pay down the vehicle as it depreciates. It will also help protect the borrower from owing more than it is worth when it comes time to trade in the vehicle.

While a longer term can be easier on the monthly budget, keep in mind that it’s possible you may need to keep the car for at least the length of your loan term. You may love the car now, but before taking out a loan for six years, consider if you will still love the car that far into the future. The risk with a longer term is the value of the car might depreciate more quickly than the balance on the loan is paid off, potentially eliminating any equity or even resulting in owing more than the vehicle is worth. This may not be an issue if you keep the car until the loan is paid in full, but if you decide to trade early it could make getting into a different vehicle more challenging. To help avoid this, research how well your intended vehicle holds its value.

Also, while newer cars will cost more than older cars, older cars come with higher interest rates. This is because the value of a used car is less certain. It’s more likely a used car could have an underlying issue due to wear and tear, while a new car is fresh from the manufacturer. Every buyer must weigh the pros and cons of a higher priced new car or a used car with higher interest.

Where to finance

It might seem easy to finance your vehicle right at your dealer’s desk or through a large national lender. But many buyers choose their local community bank because they value the personalized and relationship-based experience of working with a community bank. Typically, dealerships use larger finance companies to pull your credit report and decide based upon that information. Whereas a local bank loan officer can sit down with you and really take a look at your finances to make sure you will be able to make the monthly payments.

Having someone local who can walk you through the process can make all the difference for a first-time car purchase. Remember, a vehicle dealer may be less concerned about your overall financial picture, and more focused on landing their sale. A community banker’s perspective is to help determine what you can afford without risk of defaulting on your loan.

How having a co-borrower works

Another thing to keep in mind when applying for that first loan is that you may need a co-borrower if you don’t have established credit. A co-borrower is someone who already has a positive established credit record and is willing to help you obtain your loan. It’s important for the co-borrower to know that they are equally obligated to pay back the loan if your circumstances change and you cannot fulfill the commitment. Co-borrowers can be a parent, spouse or family member. Though some lenders will accept a friend as a co-borrower, we don’t recommend putting potential financial stress on a friendship.

Learn more about consumer loans at The Bank of Missouri

We hope this basic outline of the auto lending process helps as you embark on building your credit and purchasing a vehicle. Understanding how to budget for a down payment, the differences in lenders, term lengths and co-borrowers will give you the knowledge needed to follow the process with confidence. We hope we’ve removed some of the mystery surrounding auto loans. Our best tip to look out for you is to send you to the banker you already know and trust to help with your financing needs. Know your budget, what you can afford and plan well so you can enjoy the process of buying your vehicle and establishing credit for the future.

Whether you’re buying your first vehicle or upgrading to something new, our team is here to help you finance with confidence.