How Auto Loan Financing Works

Vehicles can be pricey, so many people use auto loans to finance them. Taking out a loan is a big decision, so before you apply, make sure you understand how auto loans work.

What Exactly Is an Auto Loan?

An auto loan is a type of instalment loan that is used to buy a vehicle. It’s a legally binding agreement between you and the lender that says they’ll give you the money to buy a car in exchange for you repaying the full loan amount plus interest by a certain date.

What Is the Process of Obtaining an Auto Loan?

An auto loan can help make purchasing a vehicle more affordable by dividing the cost into monthly payments over time. Auto loans can range from a few thousand dollars to $100,000 or more. They typically have repayment terms ranging from 24 to 84 months, depending on the lender. The amount you can borrow will be determined by the vehicle and your financial situation.

Payments on an auto loan are applied to both the principal loan amount and the interest charged by the lender. The interest rate you qualify for will determine your overall interest costs. In general, the higher your credit score, the better your interest rate. Many lenders also provide lower interest rates to borrowers who choose shorter repayment terms.

How to Become Eligible for an Auto Loan

To be approved for an auto loan, you will typically need the following:

Good Credit

You’ll typically need good to excellent credit to qualify for a reasonable interest rate. Many lenders also provide lower interest rates to borrowers who choose shorter repayment terms.

Lenders will review your credit to determine your creditworthiness. Most require good to excellent credit to be approved—a good credit score is typically 670 or higher. Some lenders offer loans to borrowers with bad credit, but these usually have higher interest rates than loans given to borrowers with good credit. 

Verifiable Earnings

You must demonstrate your ability to repay the loan. To do so, you’ll typically be required to provide information about your financial situation, beginning with your income—so be prepared to provide pay stubs or a copy of your tax return.

Debt-to-Income Ratio is Low

Your debt-to-income (DTI) ratio is the difference between your monthly payments and your income. Your DTI ratio should be no higher than 50% to be approved for an auto loan, though some lenders require lower ratios.

The loan term (or repayment term) is the time you have to repay your loan. Depending on the lender, auto loan terms typically range from 24 to 84 months. To keep your interest costs as low as possible, it’s usually best to choose the shortest term you can afford. Keep in mind that many lenders offer lower interest rates on loans with shorter terms.

Furthermore, while this frequently refers to your repayment period, keep in mind that the phrase “loan terms” can also refer to loan details such as your monthly payment, interest rate, and due date.

If you are looking for competitive auto loan deals, look no further than Heritage Financial CU and our extensive list of Dealership partners. They will help you with your auto loan needs.