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  • Auto Loan Terms

    Applying for an auto loan can be as confusing and intimidating as buying a car, especially for the uninitiated. But, knowing some of the common loan terms makes grappling with this matter easier.

    Term Length

    This means the amount of time you have before your loan hits its maturity date (that’s when the loan must be paid off). It’s usually expressed in months, such as a 48-month term.

    Term lengths typically range between 24 and 84 months. Most borrowers settle on 36- to 48-month terms, although longer ones are becoming increasingly common. Generally, you can’t finance a used car with the longer term loans.

    Longer loans can mean lower monthly payments. But, you’ll be paying more to the bank in terms of finance charges. That’s why unless you can find an outstanding deal, most financial gurus say to go with the shortest loan feasible.

    Of course, you can always take out a longer-term loan and just pay it off ahead of schedule. But, some lenders charge an early termination fee for doing so. Plus, you’re paying the bulk of the interest rate charges in the initial years of the loan.

    Don't forget that you may be able to refinance your loan if you come across a more favorable loan later.

    Down Payment

    This is the initial deposit you make to the car seller; the down payment is not part of your loan―although it does affect it.

    Some car buyers use their trade-in (see below) as their down payment. Others opt for cash or a check. Still others use a combination of their trade-in and cash or a check.

    How big a down payment should you make? As much as you can reasonably afford, according to most financial advisors. The bigger the down payment, the smaller a loan you’ll need―and the more you’ll save overall. This is especially true if you can’t find a loan with a low interest rate.

    Besides meaning you’ll need to borrow less, a significant down payment acts as a show of good faith to lenders, and can result in a more favorable auto loan.

    However, most new car buyers skimp on their down payments, typically forking over less than five percent of the purchase price, even though many experts recommend a minimum of 20 percent. If you can’t swing a large initial payment, try to minimize the damage by taking a shorter loan and making bigger monthly payments.

    Trade-in

    Is the car seller interested in buying your current car? If so, that’s considered a trade-in. That means you’re essentially swapping―or trading―cars.

    Again, you can use your trade-in as your down payment on the new car. But, if you’re considering selling your car to a dealer, keep in mind you can often get a higher price from an individual buyer. And, you can still use that money for your down payment.

    Upside Down

    While being upside down on your car loan won’t make you dizzy, it can make you feel nauseated.

    That’s because being upside down means you owe more on your car than it’s blue book or fair market value. While this is a common situation ―due to the large, disproportionate depreciation cars experience during their first few months―you want to be in this condition as little as possible.

    The best way to avoid the upside-down trap is through a hefty down payment. If you make a 20 percent deposit, and your car depreciates by 25 percent during the first several months, you won’t be upside down for long, thanks to your monthly payments.

    Some buyers combine expensive cars, meager down payments, and small monthly payments, and find they’re still upside down a few years into their loan. And, that’s a recipe for a financial disaster.

    Amortization

    This mouthful of a word means paying a debt through installments, such as with a car loan.

    Amortization tables break down the principal and the interest you’ll pay each month throughout the life of your loan, as well as showing your remaining balance. After viewing an amortization table, you’ll plainly (and perhaps painfully) see how the initial loan payments are heavily weighted towards paying the interest instead of the principal.

    Additional Information

    Don’t let baffling auto loan terms rattle you or keep you from making intelligent decisions.

    Instead, let our glossary guide you, and ask the lender plenty of questions before signing the application.