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Loan Basics
By Jon Acuff Published: 04/11/2009
Loan Basics
By Jon Acuff
Loans aren't fun and that's OK
Let's be honest—applying for a loan will never be as fun as test driving a new convertible. The rush of the wind, the open road, the growl of the engine. All of those things are great, but you know what's even better? Seeing that vehicle in your driveway, and that's something loans make possible.
In this article, we'll give you a high-level look at what a loan is, what it costs, where you can get one and what the benefits are.
What is a loan?
In the simplest terms, a loan is a way to afford something you want when you don't have the money you need. It is a financial agreement through which you borrow an amount of money from a lender with the understanding that you'll pay it back through regular installments over a set period of time. Unlike a lease, when you complete the terms of your loan, you own the car.
In addition to the amount of money you borrow, your payments will depend on the interest you are charged by the lender. The money you pay on the price of the car is considered the principal charge. The money you pay on the interest is considered the finance charge. Your monthly payment is comprised of both the principal and finance charges.
How much does a loan cost?
There are several different ways to answer that question. One easy way to figure out the cost is to multiply your monthly payment by the number of payments you'll make to complete the loan.
For example, let's say you took out a $20,000 loan on an SUV. Your monthly payment is $356 per month. The term of your loan, which is the length of time you have to pay it off, is 60 months. If you fulfill the requirements of the loan by making equal payments over a five-year period, you will pay $21,360 for the opportunity to borrow $20,000. The additional $1,360 reflects the interest you paid.
But what about the interest rate? What happens if you put cash down or trade in a car? How do you figure out the monthly payment? To find those answers and many more, try our Payment Calculator or Affordability Calculator. You'll get an instant look at the numbers that matter most to you. Or you could use our Purchase vs. Lease Calculator to see the difference between these two popular financing methods.
Where can I get a loan?
There are three primary places to find a loan:
1. Online
If you're reading this article, then you're already comfortable finding what you need online. Why not a loan? Internet-only finance companies offer attractive rates and the convenience of having your financing taken care of before you visit a dealership. There are several options available. AutoTrader.com's official online financing partner is Lending Tree.
2. Banks and credit unions
The traditional financing route is still very popular and may be the option that works best for you. In many cases, the institution where you currently have a checking or savings account is an easy place to start a loan search. Don't be afraid to expand your search to other banks and credit unions in the area as you look for the greatest offer.
3. Dealerships
Financing through a dealership is a good way to complete the entire car purchase in one location. Dealerships have access to several lenders and will search a variety of options to find the one that's best for you. Plus, new car dealerships often have special incentives and offers directly from the manufacturer.
The number of dealerships offering their own financing, referred to as "in-house financing," has also increased. The fastest growing segment of this approach is what's known as Buy Here Pay Here dealerships. These dealerships specialize in financing people with lower credit ratings. To learn more, read Buy Here Pay Here Financing Basics.
What are the benefits of an auto loan?
1. Money when you need it
Life is unpredictable. Loans help manage that unpredictability by giving you the freedom to make the purchases you need, like a car, while spreading the payments out over a manageable period of time.
2. Opportunity to build your credit history
One of the ways to establish a solid credit history is to make timely payments on an installment loan. If you consistently make payments on a car loan, for example, your credit history will grow over time and give lenders the assurance that you know how to manage credit.
3. Credit flexibility
If you've had some financial challenges in the past, you may find that it's difficult to get approved for a lease. In general, loans offer more forgiveness when it comes to your credit history.
4. Ownership
Unlike a lease, you build equity in the vehicle and own it outright when you complete the terms of the agreement. There can be a great satisfaction in holding your own car title.
5. Wider selection of vehicles
Although used car leasing is growing in popularity, most leasing companies prefer to lease cars that are three years old or newer. What if the model you want is five years old? A loan will open the door to a broader selection of model years to choose from.
If you'd like to know more about how a loan could make sense for you, read 5 Signs You Might Love a Loan. To learn about the lease side of the car financing world, take a look at Leasing Basics.
