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Car finance 101 : Everything You Need to Know

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Car finance 101 : Everything You Need to Know

Financing Basics

Buying or leasing a car can be one of the largest financial decisions you make. Finding the right vehicle and payment plan that best fits your budget is essential to making the right choice. Financing your new vehicle sounds complicated, but we're here to help by answering all of your questions, so you can make an informed decision that makes sense for you.

Auto Finance Terminology

With car financing, things are a little bit more complicated than they are with home mortgages. This section is intended to be a quick and dirty primer on lump sums of money, interest rates, and automobile finance.

#1) What is a finance contract? A finance contract is the legal document that outlines how you will repay your debt. It's not as simple as asking for the amount of money you want to borrow and paying it back in a certain time period, however; there are fees involved like administration fees and origination fees that often make this sort of thing costlier.

#2) How does interest work? Interest is the amount charged on an amount borrowed by the bank in exchange for giving them money. If you lend $1000 at 5% (an APR of 5%), your bank will deduct $5 from your loan every month until repayment date plus 1 day after that date until they have received all you owe them. The APR would be applied over this term as well, meaning if you pay off the loan at 12 months, there would be no further interest charges (hence no APR).

#3) What is an "interest rate lock"? An interest rate lock provides protection against variable interest rates with an adjustable cap. You can adjust either up or down when going over a specific dollar limit set by the lender before it locks in at its current rate from then on out (exact wording may vary). In other words, if you go over the cap by $10 each month before locking, it's locked at 6%, but if you go over by $10 each month after locking and before repaying your balance in full (or something similar), it will reset to 6% instead so long as your payment goes under that cap for some length of time first.

The Cost of Financing a Car Loan

When the time comes to make the final decision on how you want to finance your new car, it helps to understand what's involved. There are things you'll want to know before you go shopping for a loan, and there are some things that could affect your choice of auto financing.

  • Down payment. It's possible that you could become obligated to pay additional money if you don't have enough cash available at the time of purchase. This money usually has to be paid during the term of the loan, which is a maximum of 60 months (about five years). However, there is no penalty for paying off a car in less than five years; this is known as equity release and it's an option available if necessary.

  • Interest rate. Your interest rate covers all expenses associated with your loan, including interest that accrues throughout the term of your loan and also includes any capitalized interest (the amount of money you would have earned if your vehicle had been put up for sale beforehand). The lower your interest rate, the more comfortable you will likely be with what will happen after your term expires—most people would rather pay less than more in interest over time.

  • Term length."You can select from different loan terms ranging from three to 60 months," says Jim Roche, vice president at Focus Auto Finance Centre in Dartmouth, N.S., "On an effective-interest basis ," he explains,"you actually get a slightly better deal by going longer."

How Do You Finance a Car?

There are a few options when it comes to financing your vehicle purchase:

  • A bank or credit union. If you’ve been with your same bank for years and have an established relationship, this is one of the easiest ways to get a car loan. Just make sure you shop around first, because you may be able to find more favorable terms elsewhere.

  • An online lender. Online lenders can offer some of the most competitive rates on car loans, and they often don't require any money down on your part. Just make sure that you read reviews and check out the company's website before applying: there are scams out there.

  • A dealership's finance department. Dealerships typically have several different financiers (banks or credit unions) that they work with directly, so they'll shop around on your behalf to get the best rates available - which can help save you time while still getting great rates!

What Does it Mean to Finance a Car?

A car loan is a form of credit that enables you to get the car you want now and pay for it over time. Instead of paying the full amount upfront, you'll pay back the purchase price of your vehicle in monthly installments. You may have to pay interest on your loan depending on how much credit you're given, but this is fairly typical when financing a major purchase such as a car.

At some point, your car loan will be paid off and you'll own the car outright.

What is the loan-to-value ratio?

Your loan-to-value ratio is calculated by dividing the amount you want to borrow by the value of your car. The LTV for most loans is 100%. Because a used car’s value is lower than that of a new vehicle, your LTV will be higher. Your LTV also increases if you put little or no money down.

A low LTV can help you qualify for a lower interest rate because less money needs to be borrowed and the risk to the lender is reduced. A low LTV can also help you avoid private mortgage insurance if you don’t have enough cash on hand for a 20% down payment or more.

What Are the Terms and Conditions of an Auto Loan?

The number one most important thing you can do when you're shopping for a car is to get a pre-approved auto loan. The difference between getting a loan with an approved credit score, and one without approved credit score, can be everything. Without an approved credit score, your interest rate will be higher, the terms of your loan may have fewer options, and you won't be able to choose which payment options are best for you.

In this guide I'll explain every detail about auto loans so that you know exactly what you need to know before signing on the dotted line.

What Documents Do You Need to Finance a Car?

Most lenders will also want to see proof of income and a few other documents. You'll need:

  • Proof of your current income. This could be two different things depending on the lender or their requirements. If you're just starting out, you'll likely want to show your most recent pay stubs, which should be for at least three months. Don't worry about showing more than that (unless the employer is giving raises). If you're going on vacation for a while, it's not terribly important to have this document dated (but it may still be helpful if you go on vacation fairly frequently).

  • If they ask, show proof of your current/recent residency/residency history and address (utility bills, etc.)

  • Showing proof of insurance and tax info is optional but recommended by many lenders. All this means is that you have responsibility insurance in case something happens to your vehicle while it's in the shop and that we can prove a connection between us and our insurance company; i.e., we're not trying to hide something from them by claiming not to live here or use our vehicle here. The data could come from whatever source; it doesn't matter if it's from an online subscription service like mylarprinting@gmail.*com* or something homemade like a printed form with stamps or copies of utility bills attached at home or work.* A representative can usually give the lender more information about the type of coverage you have so there's no reason why they wouldn't get what they ask for just because their requested information isn't readily available online!

How To Calculate Your Vehicle Payment

  • Start with the car's price, then use the following formula to calculate your monthly payment:

  • L = P [r(1+r)^n]/[(1+r)^n-1]

  • L = loan amount (principal plus interest)

  • P = principal or car price you wish to finance

  • r = monthly interest rate (annual percentage rate divided by 12 months). If the APR is 5 percent, your monthly interest rate would be 0.004167 (0.05/12=0.004167).

  • n = number of payments until you are debt free

How to Build Credit After Bankruptcy, Repossession, or Foreclosure

If you've filed for bankruptcy, had your car or home repossessed, or are in the process of foreclosure, it's time to take steps to repair your credit. For many people, a car loan is the first step toward rebuilding their credit history. However, if you're looking for a car loan with bad credit after bankruptcy or other negative financial issues on your credit report, you might not know where to start.

Here are 6 tips that can help.

  • Focus on paying off debt.

  • Make all payments on time.

  • Get a secured credit card.

  • Become an authorized user on an established account (to increase length of positive payment history on your report).

  • Use a small amount of available credit each month (to demonstrate that you can use debt responsibly and make payments).

  • Don't apply for too many cards at once (because this will negatively affect your score).

Bad Credit Auto Loans 101

Simply put, bad credit auto loans are loans for people with poor credit. If you’re asking “what is a bad credit car loan,” then you probably have poor or no credit. These loans are often secured, meaning that the lender has some collateral—in this case your car—that they can take and sell if you don’t pay back the loan.

However, there are several important things to know about bad credit auto loans before agreeing to one:

  • Bad credit auto loans often have higher interest rates than regular car loans. This is to help offset the risk of loaning money to someone who doesn’t always pay their bills on time.

  • Bad credit auto loans also typically require smaller down payments and have lower loan-to-value ratios (LTV). This means that if you get a bad credit car loan for $10,000 at an LTV of 80%, then your vehicle must be worth at least $12,500 (80% of $12,500 = $10,000). Keep in mind that when it comes to buying cars with cash or financing them through an auto loan or lease—the Residual Value matters a lot!

Ready to finance your first car? Learn everything you need to know about auto financing with this guide.

In your life, you’ve probably had to finance many things: a cell phone payment plan, a student loan, rent or a mortgage. But what about financing or leasing a vehicle? You may not know where to start. That’s why we created this guide—to answer all of your car financing questions and explain exactly how the process works so you can get into the driver’s seat as quickly and easily as possible.

To get started, take our quiz below to find out if you should lease or buy your next vehicle. Then keep reading for more information on car loans and auto refinancing as well as tips on how to save money during each step of the car-buying process.

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