5 Things to Look For Before You Accept An Auto Loan

The process of taking out your first auto loan can be quite daunting, particularly for those who don’t have much experience with banks or finance. Much of the jargon used by auto loan providers can be confusing for first-time car buyers, and it can be difficult to know what to look for in an auto loan agreement or whether or not you should even accept it. There are certain indicators that you can look for to determine whether or not you should accept a loan, regardless of how much you know about cars or finance. Here are five important things you need to know about what to look for in an auto loan.

1. Take the shortest loan term you can afford.

Unlike your home, which may retain or even gain value over time, your car will almost certainly depreciate in value during the time that you have it. Therefore, your biggest concern when searching for an auto loan is avoiding interest charges. Many people don’t realize until after they sign a car loan how much more they’re paying in interest than the car is actually worth. For example, if your car loan takes five years to pay off, you could end up paying thousands of extra dollars in interest that you wouldn’t accrue with a two year loan. Not only can this be quite financially detrimental, it’s also just not a good use of your money. Most dealers will try to scare you out of taking a shorter loan, and since the payments look higher on paper with a longer term loan, it often works.

Ideally, you should take the shortest loan term you can fit into your budget. Your monthly car payments will be higher, but you won’t be making payments for as long, which means not as much interest will accrue. Banks also tend to charge higher interest rates on longer loans anyway, which means you’ll pay even more than the car is actually worth. Of course, it’s important to be realistic about how much you’ll be able to spend each month, but finding a happy medium will be good for your wallet in the long term.

2. Read the fine print to avoid prepayment penalties.

Some auto loan companies charge penalties on making extra payments on your auto loan. This is something many car buyers don’t know, and it’s often used to their detriment so it's definitely what to look for in an auto loan. The prepayment penalty is usually a ‘small’ percent of the overall loan - for example, they might ask for four percent of a $200,000 loan, which would be $8,000 - no small sum. Before signing a loan, you should both read over the document and ask your lender what their policy is regarding prepayment penalties. If you can avoid prepayment penalties altogether, you should. Having the option to pay down your loan faster than the initially set terms can save you thousands of dollars in the long run on interest. Many loan providers don’t refer to these as ‘penalties’ in their documentation, so it’s important to clarify any language you don’t understand. 

3. Aim to put at least 20 percent down up front.

This is something that’s very important to do but often disregarded. To avoid your interest costs piling up, you should plan to put down 20 percent or more when you first purchase the car. Some lenders will try to talk you out of this, because they benefit when you pay more money in interest on the car loan agreement, but it’s important to stand your ground. Yes, it’s always a bit intimidating to write that large check at first, but it will help you in the long run when you own your car outright very quickly. This is also a good guideline to use to help you make sure the purchases you’re making are realistic. If you can’t afford to put down 20 percent on the car, chances are you should be opting for something a bit more affordable.

4. Are you getting the best interest rate considering your credit?

The unfortunate truth is that if your credit is poor, your interest rate is going to be high. And while that’s typically just how the system works, there are things you can do to make sure you’re getting the best possible deal considering your circumstances. Your credit and the way your credit affects the overall interest rate are definitely two of the biggest things to look for in an auto loan. The first thing to do is just shop around before committing to a loan - try local banks and credit unions, or even an online lender, instead of just going with what your dealer can offer because it’s easy. You’ll also want to double check your credit score and make sure as much of your debt is paid off as possible - even making a few small payments can add up to a lower interest rate. It’s also important to revisit your car loan agreement every six months to a year and see if you can refinance. If your credit score improves or you’ve been particularly diligent about making your monthly car payments, you may be able to get a lower rate on your auto loan.

5. Make sure you can really afford this car.

This may sound simple, but so many people get talked into cars they can’t afford because they can get a low monthly payment on them. Just because you don’t have to spend much on the car right now doesn’t mean that you can actually afford it or that you even need it. When shopping for a car, don’t focus on buying the flashiest or biggest car you can get a loan for - think about what’s practical, what will last you a long time, and what you can realistically afford to pay off over the next few years. The result may not be your dream car, but it will be a car that’s useful and reliable.