Understanding the Different Types of Car Loans

Auto Loans for New Cars

New car loans are exactly that: loans borrowers take out to buy new cars. These loans typically have the best interest rates because new vehicles often have the longest anticipated life. Car buyers can get new car loans through dealerships, banks, credit unions, or online lenders specializing in auto loans.

Dealerships often get a commission from banks they partner with to allocate more auto loans. Potential buyers also get lower prices on the cars they plan to buy if they finance through dealerships.

Auto Loans for Used Cars

Buyers can also get used car loans from banks, dealerships, online lenders, and credit unions. However, it's worth noting that getting used car loan approval for an old car can be difficult because most lenders only finance cars under a certain mileage or age limit.

Simple Interest Loans

For simple interest loans, the lender calculates the borrower's monthly payment based on their interest rate, daily interest accrued since the last complete payment, and the loan balance. It's the most common type of auto loan in use today, where each month's payment first goes toward the interest amount, and the remainder goes toward the principal amount.

Simple interest loans also allow borrowers to make additional payments in addition to their regular monthly payments. Borrowers can pay off their loans early, saving more on interest charges.

Pre-Computed Auto Loans

For pre-computed auto loans, the loan balance, interest, and origination fees are calculated at the beginning of the loan. They're then divided across the loan term, allowing borrowers to enjoy a fixed monthly payment, rigid payment schedule, and fixed interest rate.

A percentage of what goes toward the borrower's principal may be used to cover any fees incurred because of late payment fees. Monthly payments are often lower than simple interest loan payments. However, borrowers are not incentivized to pay off this loan type early.

Lease Buyout Loans

These loan types allow car owners to purchase the cars they've been leasing. The vehicle owner can take a lease buyout loan to keep the vehicle or sell it again if it's worth more than the lease buyout. Car owners can get lease buyout loans directly through banks, credit unions, dealerships, and online lenders.

Refinancing Loans

Refinancing auto loans allows borrowers to replace their existing loans with new ones. The borrower can refinance an auto loan through credit unions, banks, and online lenders. For example, suppose a borrower took out an auto loan when their credit score was lower and received a high-interest rate. In that case, they may get a significantly lower interest rate by refinancing the loan. This could drastically lower their monthly payments.

We advise borrowers to consider the new interest rate, new monthly payment amounts, and any fees associated with the refinanced loan before agreeing to its terms. Ensure the refinancing benefits you in the end by lowering monthly payments and allowing you to pay off the loan sooner.

Bad Credit Auto Loans

Some dealerships and lenders offer bad credit auto loans to borrowers with low credit scores. These loans allow for more flexible credit score requirements than most conventional auto loans. However, they often fetch higher interest rates.

Most lenders consider borrowers with poor or no credit a high risk. Therefore, lenders compensate for this risk by having higher interest rates on their loans. Still, it's vital to shop for competitive loan rates even with bad credit to ensure the lender isn't taking advantage of your situation.

When requesting rate quotes, verify the interest rates, monthly payment amounts, and other critical auto loan terms in writing. It's also important that the lender makes soft inquiries that won't affect your credit further.

No Credit/First-Time Buyer Loan Programs

Unfortunately, most lenders often view having no credit history as having bad credit. This can put interested car buyers at a disadvantage, especially for buyers who need a car immediately. However, if you don't need the car now, we recommend taking time to build credit to improve your chances of getting better auto loan terms.

There are also dealerships specializing in first-time car buyers. Some banks and online lenders may also offer financing for buyers without a credit history. Most dealerships near colleges are great places to start for the best chances of finding an auto loan at a good rate as a first-time buyer.