Your First Car Loan: The Basics

Have questions about financing your first car? The process can daunting, especially for first-time buyers. And, you can’t afford to gamble with your car loan. JD Power and Associates newest report found the average auto transaction for January 2018 was at $32,169. That’s a big investment.

In order to get the best rates, check out some key ideas and terms below.

Budgeting

A realistic budget must be established before shopping for an auto loan. Without this, it's too easy to fall in love with a car, take out a loan that is too expensive, and struggle with payments. A budget should also include other ongoing costs, such as maintenance, comprehensive car insurance, gas and repairs. If making a car loan work into your budget is difficult, consider saving for a larger down payment.

In addition to ongoing costs, figure out the extra costs that you’ll encounter at the dealership: sales taxes, licensing, and others.

Also, consider the resale value of the vehicle you are purchasing. Depreciation often becomes a hidden cost when taking out a car loan. Before signing on the dotted line, find out the resale value of the vehicle and factor depreciation into your loan budget.

What To Look For In A Car Loan

Factoring in interest rate and loan term is crucial. The term is usually expressed in the number of months, while the rate is expressed as a percentage. Rate and term have an inverse relationship. Loans with longer terms have higher rates.

When considering the term, always account for how much mileage you plan to put on the vehicle. High mileage drivers (over 20,000 per year) need to account for the fact that they will be replacing the car sooner. If these buyers take out a loan term that is much longer than the car will last, the result is substantial negative equity.

To avoid this, try and make the term match your driving habits. Many buyers find that the minimum payment for ideal term lengths is too high. They have little choice but to take out a longer-term loan. These buyers should be wary. Though they may need the car and have to take the longer loan, they can reduce negative equity by making extra payments toward the principal each month.

Insurance

A new car loan means higher insurance premiums. Every state requires a minimum amount of liability coverage, but finance companies require all borrowers also carry comprehensive coverage. When choosing an insurance company and insurance coverage limits, consider how much insurance you need to protect your assets.

Comprehensive coverage pays for repair and replacement of your vehicle after an accident. Should your vehicle be totaled, your insurance company receives your policy's proceeds, up to the amount financed. If you have equity in your vehicle, you may receive a check for that amount. If you have negative equity, you owe the difference to the finance company. To avoid owing money on your car after it is totaled, purchase gap insurance at the time you get your loan. Gap insurance covers any negative equity, so you owe nothing out of pocket.

How To Shop

Before heading to the car dealer, it's a good idea to have pre-approved financing in hand. First, this gives you leverage in negotiation. This also gives the dealer incentive to try and beat your financing rate. Dealers often make money on financing through a reserve, which is a premium the dealer gets on each loan. When you have pre-approved financing, they will cut reserve to the minimum in order to compete.