When you’re ready to finance a car, you may be wondering what type of auto loans there are to choose from, and which one will best suit your needs. There are many different types of loans and financing options when it comes to car loans. It’s important to know what’s available, so you can make an informed decision on your car purchase.
Secured vs. Unsecured Auto Loans
Two main types of loans are secured and unsecured. Both have their pros and cons, so it’s important to consider your options carefully before making a decision.
With a secured loan, the car itself serves as collateral, which means the lender can repossess the vehicle if you default on the loan. This can make it easier to qualify for a lower interest rate, but it also means you could lose your car if you can’t make the payments.
An unsecured loan doesn’t require collateral, but the trade-off is that you’ll typically pay a higher interest rate. There’s also more of a risk for the lender, which means they may be more stringent terms.
Types of Secured Car Loans
- Traditional auto loan – A traditional auto loan is a type of loan that is typically used to finance the purchase of a new or used car. The loan is secured by the vehicle, and the borrower makes monthly payments until the loan is paid off. Traditional auto loans usually have a fixed interest rate, which means that the monthly payment will not change over the life of the loan.
- Balloon car loan – A balloon auto loan is a type of financing where the borrower makes smaller payments for a set period of time, followed by a final, larger payment. This larger payment is typically due at the end of the loan term and is often referred to as the “balloon” payment. Balloon auto loans can be beneficial for borrowers who expect their financial situation to improve over time and who want to keep their monthly payments low in the meantime. However, borrowers should be aware that they will need to have the funds available to make the balloon payment when it comes due. Otherwise, they may risk defaulting on their loan or having their vehicle repossessed.
- HELOC/home equity loan – Although not directly a type of vehicle financing, a home equity line of credit (HELOC) or home equity loan is a great way to borrow against the value of your home and use the funds for major expenses. One popular use these loans is to buy a car. This can be a good option if you have equity in your home and are looking for a low-interest loan to finance a new car purchase.
Types of Unsecured Car Loans
- Personal loan – Some people choose to take out a personal loan to buy a car. Personal loans tend to have lower interest rates than auto loans, so you may save money in the long run. Personal loans can be used for any purpose, so you’re not restricted to using the loan just for a car. However, you’ll need to have good credit to qualify for a personal loan with a low interest rate.
- Personal line of credit – Though not often used for vehicle purchases, a line of credit can give you the flexibility to finance your purchase over time. Personal lines of credit typically have higher interest rates than traditional loans, so it’s important to shop around and compare rates from different lenders. Many dealers may also not accept this as a form of payment, so be sure to discuss this if you’re considering it as an option. This is not an option that we’d often recommend for a car loan.
New vs. Used vs. Certified Pre-Owned (CPO)
Deciding whether to buy a new, used, or certified pre-owned car is a big decision. Not only do you have to choose the right vehicle for your needs, but you also need to decide how to finance it. Auto loans are available for all three types of cars, but there are some important differences to consider.
- New cars usually have the highest loan rates because they depreciate the most in the first few years.
- Used cars may have lower rates, but it’s important to be aware of the vehicle’s history before you commit.
- Certified pre-owned (CPO) cars offer many of the same benefits as new cars, but with more flexible financing options.
Ultimately, the best option for you will depend on your budget and your needs.
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Different Interest Rate Methods
When taking out a loan to buy a car, there are two main types of interest to choose from: simple interest and precomputed interest.
Simple Interest Auto Loan
With simple interest, the interest is calculated based on the remaining principal loan amount and the length of time that the loan is for. This means that the amount of interest you pay will depend on how much you borrowed and how long it takes you to repay the loan.
Precomputed Interest Auto Loan
Precomputed interest, on the other hand, is calculated as if you were to pay only the minimum due every month. The interest is then added to the principal to determine your monthly payment. Precomputed interest is less common than simple interest in auto loans, however it is more prevalent in bad credit car loans than in loans for buyers with good credit.
Direct vs. Indirect Auto Financing
Another difference to consider when considering a car loan is comparing direct and indirect financing.
- Direct auto financing is when you work with a bank or credit union to get a loan for your vehicle.
- Indirect auto financing is where you get your loan through the dealership and they are the ones who finance the car.
Direct auto financing typically has lower interest rates than indirect auto financing. That’s because dealerships add a “markup” to the interest rate when they arrange financing for their customers. This markup can add up to several percentage points, which can cost you hundreds or even thousands of dollars over the life of your loan. In addition, direct lenders may be more flexible when it comes to things like loan term.
However, depending on your credit situation and finances, indirect financing through a car dealership may be a more achievable option.
Buy Here Pay Here (BHPH) Car Loans
One type of indirect financing that can be attractive to car buyers with bad credit is buy here pay here, or BHPH auto loans. These dealerships and loans are also commonly referred to as “in-house” or “tote the note”.
These “Buy Here Pay Here” (BHPH) dealerships typically offer in-house financing, meaning they provide the loans for their cars directly to buyers. This is often the option for people with bad credit, because traditional lenders may not be willing to work with them. However, there are a few things you should keep in mind before taking out a BHPH loan.
For one, BHPH loans often have higher interest rates than loans from traditional lenders. This means you’ll end up paying more for your car in the long run. Additionally, BHPH dealerships may require a large down payment, which can make it difficult to afford the car you want.
In-house financing typically isn’t the best option for car buyers that can get approved through a bank or credit union, but they can be a great option to get credit challenged car buyers into a vehicle and start rebuilding their credit.
Active Duty & Veterans Military Auto Loans
Active duty military personnel and veterans can get special financing on auto loans through many lenders. This includes loans through the Pentagon Federal Credit Union (PenFed), as well as some major banks and credit unions that provide military auto loans.
In addition, active duty military personnel and veterans may be eligible for discounts on auto loans through programs like the Military AutoSource program. Veterans who are eligible for VA benefits may also be able to use their benefits to cover the cost of an auto loan in specific situations.
Active duty military personnel and veterans should check with their lender to see if they qualify for any special financing options.
Subprime Auto Loans
Subprime auto loans are loans that are extended to borrowers with bad credit. These car loans are also referred to as “bad credit”, “second chance”, or “non-prime”.
Many of these borrowers have a history of late payments, defaults, or bankruptcy. As a result, they typically pay higher interest rates than prime borrowers. While subprime loans can be helpful for borrowers who need a car but have bad credit, they carry the same risk as other secured loans, where the car can be repossessed if a borrower falls behind on their payments.
As a result, it’s important for borrowers to carefully consider whether they can afford the monthly payments before taking out a subprime auto loan.
Other Types of Auto Loans
Vehicle Title Loans
A vehicle title loan is a type of short-term loan that uses your car as collateral. The amount you can borrow is based on the value of your car, and you typically have to repay the loan within 30 days. One of the biggest advantages of a vehicle title loan is that it doesn’t require a credit check. This makes it a good option for people with bad credit or no credit history. However, there are also some drawbacks to consider. For instance, if you can’t repay the loan, you could lose your car. Additionally, vehicle title loans often come with high interest rates, which can make them very expensive in the long run.
Private Party Car Loans
While buying a car from a private individual can be a great way to get a car that’s not available through traditional dealerships, it’s important to understand the process and what’s involved. You will have to apply for and secure financing directly with your bank or credit union unless you’re able to buy the vehicle outright and in full. Dealership financing options aren’t available in private party car purchases, so borrowers typically will need good credit.
A lease buyout is when you purchase the car you’ve been leasing. You may choose to do this at the end of your lease term, or you may exercise a lease-end option to buy the car earlier. The price of the buyout is typically set in your original lease agreement. If you’re considering a lease buyout, it’s important to understand all the costs involved. In addition to the purchase price, you may be responsible for taxes, fees, and any remaining balance on your lease. Once you purchase the car, you’ll be responsible for all future repairs and maintenance.
Auto Loan Refinancing
Auto loan refinancing is the process of taking out a new loan to pay off an existing auto loan. There are many reasons why someone might choose to refinance their auto loan, including getting a lower interest rate, increasing the term of the loan to get lower monthly payments, or both.
The process of refinancing an auto loan is fairly simple; the borrower applies for a new loan and uses the proceeds to pay off the old loan. If approved, the borrower then makes monthly payments on the new loan according to the terms of the agreement. Auto loan refinancing can be a great way to save money on your car payment, so it’s worth considering if you’re looking for ways to reduce your monthly expenses.
Choosing the Right Type of Car Loan
There are many options to compare, consider, and choose from when it comes to auto loans. Some of the key factors that you’ll need to analyze to determine what type of auto loan is best for you include:
- Your finances – monthly payment budget, down payment, auto insurance
- Your credit – are you able to get direct financing with a good rate, or do you need to explore dealership financing or subprime auto loan options?
- Your vehicle – What are your needs vs. wants in a vehicle, and how does that impact your budget?
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