If you’re looking to purchase a new or used vehicle, you’re likely also considering a vehicle loan to pay for your purchase. Very few consumers have enough money to pay for a vehicle upfront, so most take out loans. You can procure a vehicle loan from various lenders, from traditional banks and credit unions to financing through the dealership and even online marketplaces designed to offer auto financing. In addition to multiple lenders for vehicle loans, you’ll find a variety of loan types available for funding. Let’s explore the different kinds of vehicle loans.
What Is a Vehicle Loan?
When you purchase a new or used vehicle, you can apply for a vehicle loan, where you agree to borrow a set amount of money to buy the vehicle. You pay this amount back to the financial institution via monthly payments for a set term and at a predetermined annual percentage rate (APR). Several factors determine the details of your loan, such as:
- Your income
- Credit score
- Vehicle age
- Type of vehicle
- Term of loan
- Down payment
Generally, the better your credit score, and the newer the vehicle, the lower the APR on your vehicle loan. It might also reduce your APR if you make a down payment and/or a trade toward the vehicle purchase as a down payment. You can use a loan calculator to determine what loan payment fits into your budget.
Types of Vehicle Loans
Various vehicle loans are available through banks, credit unions, dealerships, and the online marketplace. Knowing what each type of loan entails will help you select the right one for you. According to LendingTree, types of vehicle loans include:
A secured loan is the most common type of vehicle loan, where you use the vehicle itself as collateral for the loan. The lender will put a lien on the vehicle, meaning that if you default on the loan, they can repossess the vehicle. You can also procure a secured loan using other items you own as collateral, such as your home or boat. You can get a traditional secured loan for new cars and used cars with the monthly payments spread out equally over the term of your loan.
A second type of secured vehicle loan is a balloon loan with relatively small payments for the first few years, ending with one large (balloon) payment. You can also take out a secured loan for a business or fleet as a small business or government entity. You can also use a home equity line of credit (HELOC) to purchase a vehicle. Although not a standard secured auto loan type, it uses your home as collateral.
Although very rare for vehicles, you can apply for an unsecured loan. These loans include personal loans, personal lines of credit, and credit cards, and often have exorbitant interest rates. This type of loan is often used if the amount you want to borrow is less than the lending institution’s minimum origination amount or if the vehicle doesn’t qualify as collateral. This disqualification is often because of high mileage or age.
Simple Interest Loan
A simple interest loan calculates the APR daily, so as you pay down your loan, you also pay less each month for interest. Your car payment remains the same throughout your vehicle loan, but as time goes on, you’re paying more toward the principal and less overall interest. A simple interest loan reduces the total interest paid on your loan if you make early or extra payments or pay a little more each month.
Pre-computed Interest Loan
For a pre-computed interest loan, your monthly payment, amount of principal, and interest will be the same each month. For example, if you borrow $25,000 for 60 months at 4.5%, the total interest for the loan is $2,964.53, making your total loan amount $27,964.53. Your car payment each month will be $466.08 based on the total amount of the loan so the lender is guaranteed the $2,964.53 interest.
Direct Auto Financing
When you apply for a loan by interacting directly with the lender, it’s called direct auto financing. You’ll fill out one application and interact with the lender yourself. This type of financing is done through your local bank or credit union. You can apply for direct auto financing through more than one lender. You just have to complete a loan application for each one.
Indirect Auto Financing
If a third party acts as a go-between for you and the lender, it’s called indirect auto financing. This type of financing is how the online marketplace works. You fill out one application, and the third party shares that information with various lenders to provide you with multiple offers to finance your vehicle. This financing is also the type dealerships use when you finance through them. They work with various lenders who provide you with offers, so even though you’re working directly with the dealership, you’re not working directly with the lender.
Preapproved Vehicle Loans
Your bank or credit union might be able to provide you with a preapproved vehicle loan. A preapproved loan might give you a blank check to write out to the dealership or the ability to write the check from your personal account with the guarantee you have the loan to back it. This type of loan is beneficial because it gives you the edge in negotiating on a vehicle — it’s essentially like paying for the vehicle in cash.
It’s important to know the difference between preapproved and pre-qualified. Pre-qualified simply means the lending institution is willing to consider loaning you the funds, and might be less accurate or guaranteed than a preapproval. Pre-qualification means you’re likely to be approved based on your financial situation, but the lender has not gone through the rigor of reviewing supporting documentation for income, debts, and assets.
When it’s time to shop for a new or used vehicle, remember the various types of vehicle loans to ensure you get the right one. Be prepared to complete one or more applications to compare rates and terms of loans from multiple lenders to know you’re getting the best value.
At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.