The Full Guide to Auto Loan Types

ByBestmoney StaffDec. 31, 2020
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Everything you need to know about auto loans
Between striking the proper balance of pricing and determining the necessary features that fit into a customer’s ideal vehicle, finding the right car can take time. Unlike other purchases, a car will stay with the customer for years, and a car’s high price tag means that most people will choose some form of financing instead of paying for it outright.

Luckily, most banks and lenders offer loans and credit solutions specifically designed for auto purchases. However, it is important to know that not all car loans are created equal, and customers who educate themselves on the many varieties of loans available have a real advantage.

In addition to standard new car loans, customers can select options for pre-owned vehicle financing, leasing, and can even refinance their existing auto loans. Read on to discover the diverse range of auto loan options, and how to benefit when choosing your next financing solution.

Auto Loans for Car Purchases

Most traditional auto loans are extended to customers for the purchase of either a new vehicle or a pre-owned one. These loans work similarly to personal loans, with lenders assigning a principal and interest rate, and borrowers repaying the amount borrowed over a set term. However, auto loans can have different combinations of interest rates and payment structures that make them more advantageous for certain circumstances. Some of these include pre-computed loans, simple interest loans, and secured or unsecured loans.

Pre-computed Loans

Pre-computed loans are standard loans which include principal and interest amounts, but with a small twist. With this type of financing, borrowers and lenders agree on the repayments for both interest and principal amounts and the sum is included in the paperwork. For borrowers, this means that these non-negotiable, final payments can be prepared in advance. A major advantage of pre-computed loans is the peace of mind they grant borrowers. Customers do not have to worry about changing rates and payments, and can set aside enough money every month well in advance, making it easy to budget for other expenses. On the other hand, these kinds of loans do represent one major obstacle for borrowers—in that they cannot be prepaid to save money on interest. Because sums are agreed to contractually, customers must pay the amount set at the beginning, including the pre-calculated interest amount.

Simple Interest Loans

Simple interest loans are like traditional loans, but the difference is that interest is calculated daily - based on the amount of debt that remains outstanding. In this case, paying off the loan early is not just permitted, but is more beneficial to customers, as a lower outstanding total also means a lower amount of interest over time. This is a fantastic alternative for customers who are certain that they can pay off their loan in short order, especially for loans absent prepayment penalties. Moreover, customers who are financially stable and can negotiate lower rates thanks to a higher credit score can benefit even more by paying much less interest. For those borrowers with weaker credit or who cannot afford high loan repayment amounts, simple interest loans may not be the best option.

Secured and Unsecured Loans

Some loans require that collateral be extended (secured), and some do not (unsecured). Secured loans tend to have lower interest rates, as borrowers’ property—including any existing cars or even homes—are used as collateral to ensure repayment. With these loans, customers can benefit from lower interest if they are certain they can comfortably repay their loan. The downside of secured loans is that for those customers who fall behind on payments, their collateral can be legally taken from them.

Unsecured loans can be extended with no collateral, and generally have higher interest rates than secured loans, as they involve higher risk for lenders. Customers can take advantage of loans that are extended in good faith and not worry about repossession in the worst of cases. Unsecured loans are excellent ways to access financing without putting assets at risk. On the other hand, they do carry interest rates that can be significantly higher depending on borrowers’ credit standing.

Lease Buyouts

Lease buyout loans are ideal for customers who wish to purchase their leased car, but do not have enough capital to pay the remaining amount on their lease. Lenders will finance the outstanding amount, and treat the loan as a normal auto financing solution. Customers can take advantage of this to ensure that they own their car while still giving themselves time to repay their outstanding obligations. This is an alternative for those who are certain they will be able to continue making installments, but would prefer to not pay a hefty sum all at once.

Loans for Bad Credit

Bad credit loans are financing solutions designed specifically for customers that are faced with poor credit scores but still want or need to purchase an automobile. While not all companies offer these loans, those lenders that do tend to have programs and solutions designed specifically to help customers borrow responsibly. Bad credit loans are an excellent way for individuals to rebuild their credit considering on time payments can improve their scores significantly, and highlight their positive financial habits.

Private Party Loans

In many cases, customers are not purchasing their car from an authorized dealership, but rather from an individual or private party. Many of the traditional loan types are not available for this type of purchase, but some lenders and financial services providers offer loans designed specifically for this purpose. For these situations, loans work more as personal loans, as funds must be disbursed directly to the other party as opposed to being transferred directly to the dealer. These loans do have some advantages over personal loans, as they tend to have slightly lower interest rates and similar terms. However, they do in many cases require additional paperwork, such as mechanical inspections and other documentation for the car to ensure a reasonable return on the lender’s investment.

Refinancing Solutions

Sometimes, customers are not looking to necessarily purchase a new car, but are searching for ways to lower the payments they already make on existing loans. High repayment amounts are a result of several factors, such as bad credit at the time of the original loan, low income, or even an obscured financial outlook. As such, customers can vastly improve their loan conditions by looking for refinancing solutions. Many lenders and financial services institutions offer customers the ability to improve their original loan by extending a new one with more favorable terms. As with other loan types, not all refinancing alternatives are alike. These are just some of the refinancing solutions available to customers:

Standard Refinancing

Refinancing gives customers the ability to take out a loan for the outstanding amount on their original financing agreement, with better interest rates and in some cases a different payback period. This is a great way for customers that have improved their credit score since they originally took out their loan to lower the total amount they must repay over the term. Moreover, refinancing is a good way to ensure that loans do not balloon out of control with excessively high interest rates. Customers should be careful when refinancing, and not lock themselves into new loans that may be more damaging to their finances, which may occur when extending a loan term’s duration significantly.

Cash Out Refinancing

Some companies offer customers the ability to take out refinancing loans that have an added sum on top of the outstanding debt. This represents a positive solution for customers that are looking for better loan terms, but are also seeking extra funds for another purchase or even for repairs, modifications, and other car-related expenses. The major benefit of cash out refinancing is that the additional funds are extended at the same low interest rates and terms as the rest of the refinancing loan, so customers are still only paying one monthly payment. Customers should be careful with these kinds of solutions, as they do add to the remaining debt they must repay, and even the lowest interest rates can add up over time.

Find the Loan that Fits You

Regardless of the loan type they choose, customers should always make sure that their financing solution fits their personal financial circumstances. While some loans may offer appealing benefits and advantages, they are not always applicable, and can be harmful if used in the wrong circumstances. Borrowers should always consult with their financial advisors, and ensure that the financing solution they are pursuing grants them the easiest path towards vehicle ownership without any debt.