Understanding Auto Loan Terms

Not very many people have the luxury of paying for a brand new car out of pocket. With college loans to pay off, kids, a mortgage, medical expenses, and another car loan with several more years of payments, car buyers generally opt to finance the new vehicle through a bank or other lending institution. However, not everyone understands the terminology involved in the car loan process.

Anatomy of an Auto Loan

A car loan is a secured loan whereby the borrower pledges the new car as collateral. This means ownership of the car remains in the hands of the lending institution until the car loan (lien) is paid off. If the new car buyer is unable to continue making loan payments, the bank can repossess the car from the individual.

Auto loans are divided into two categories: direct and indirect. With a direct auto loan, the bank loans money directly to the car buyer. However, the loan favored by car dealerships is the indirect auto loan whereby they act as an intermediary between their preferred lending institution and the car buyer.

Selecting the Auto Loan Term

The length of the auto loan (term) depends on a variety of factors. If the car buyer can afford higher payments and plans to trade in the car after 3-4 years, a 36-month auto loan may be worthwhile. A majority of people choose a 48-month car loan, while some who plan to keep the car for 8-10 years and need lower monthly payments opt for a 60- or even 72-month car loan.

Auto Loan Amortization: Paying Down Debt

The car buyer will hear a lot about amortization during the auto buying process. In short, amortization means the shrinking of a debt. In the case of a car loan, it means the entire process of paying the lender monthly until the debt is fully paid off and ownership is transferred to the individual.

Here’s how amortization works. In the beginning, the car buyer pays mainly the interest on the car loan. But as time progresses, he or she will pay down the principal until the entire car loan amount is paid off. Many factors go into auto loan amortization including loan amount, interest rate, and length of the auto loan. Car buyers can search the web for amortization calculators to estimate their price point for a car purchase.

Factoring In Down Payments and Trade-ins

For a car loan, an initial up-front payment (down payment) is required. If the car buyer plans to trade in his or her car and use the dealership’s price offer as a down payment on the new car, it can lower the cost of monthly payments. Whatever the case may be, a down payment somewhere in the range of $2,000 to $4,000 is standard for the average priced car.

Auto loan terminology can seem intimidating to first-time car buyers. However, with a good understanding of how car loans work coupled with proper financial planning, car buyers can walk into the auto dealership with confidence and a solid understanding of what they can afford.