More than 107 million Americans have an auto loan. That’s more than 40 percent of the US adult population using finance to fund their new wheels.
But the different types of car loans available can be confusing and downright overwhelming, especially for first-timers. Fortunately, we’re here to guide you through the most common types of auto loans and, more importantly, which one might be right for you.
Secured Auto Loans
Secured car loans are one of the most common types. The “secured” part refers to the fact that they’re guaranteed by a lien on the underlying asset. In other words, the car.
This means they’re less risky for lenders because if you don’t pay, they have the legal right to seize the vehicle. Don’t worry, this doesn’t mean the lender will always have a right to repossess your car. Once your loan is paid off, the lien expires.
Secured loans are the most traditional auto loans. These will usually be offered for new car loans, but you may also find them available for used car loans.
There’s also a unique type of secured auto loan called a balloon loan. This loan differs from traditional auto loans due to the payment structure. In balloon loans, you make lower payments for the duration of your contract, followed by one large final payment.
Balloon loan durations vary from as little as 18 months all the way up to 60 months or more. When your final payment is due, you can opt to pay the large final payment, sell the car to pay it off, or trade it in for another vehicle.
Because they’re less risky for lenders, secured car loans generally have lower interest rates than the other main type of car loan – unsecured auto loans.
Unsecured Auto Loans
It should hopefully be obvious how unsecured auto loans differ from secured auto loans, but just in case it isn’t. Unsecured loans have no lien on the underlying asset. This means lenders cannot seize or repossess a vehicle due to late or non-payment.
Sounds great, but this pro comes at a price. Unsecured auto loans almost always have much higher interest rates than equivalent secured loans. Your specific interest rate would be calculated based on your credit score and more.
Types of unsecured loans include things like personal loans, credit cards, personal lines of credit, and even student loans. Though the higher interest rates put some off immediately, unsecured loans can sometimes be a good option.
This is particularly true for used cars. Many lenders have requirements on vehicles they will offer secured loans on. These requirements vary but usually revolve around things like age and mileage. This obviously excludes many used cars.
In an unsecured loan, the vehicle isn’t collateral so those looking at used cars may find unsecured loans a better option for them. There’s also the added benefit of no restrictions on how you spend an unsecured loan, so if you end up getting your car cheaper, you can use the spare change for something else.
Lease Buyout Loans
Lease buyout loans are a loan type available to those who wish to keep their vehicle past the end of their lease terms. The lender pays the end of lease fee and the borrower makes these payments back over a fixed term. Once all payments are made, the lien is removed from the vehicle.
Title loans are a type of secured loan. Much like a home equity loan, a title loan lets you borrow against the value of your car. The lender puts a lien on the car once the loan is issued.
Military Auto Loans
As the name suggests, these loans are only available to active duty service members and their families. For military members, unsecured loans are capped at 36 percent APR.
Home Equity Loans
Though they’re not a typical source of car financing, some use a home equity line of credit (HELOC) to buy their car. They’re similar to secured loans in that they’re secured by an asset, but in this instance, it’s the borrowers’ home instead of a car. It’s a popular option for those looking at financing for classic cars.
With the various types of loans covered, one big difference you’ll notice in all these types of car loans is how interest is calculated.
Simple Interest Vs Pre-Computed Interest Loans
Simple interest loans are the most common interest calculation you’ll come across. For these loans, the outstanding balance occurs interest on a defined periodic basis. You can accelerate the payoff and limit how much interest you pay with additional or early payments.
Pre-computed auto loans are another common interest calculation. These loans have scheduled payments that are not flexible, so you’ll always pay the same interest regardless of early payments. For those with a limited budget, a predictable payment structure may be a good option.
As a frame of reference, the average car loan interest rate in 2020 was 4.98 percent on 48 and 60-month term loans. Obviously, the rates you’ll be offered will vary depending on your credit score and other circumstances.
The only other factor to consider in your car loan is where you get the loan from. This breaks down into direct and indirect financing.
Direct financing is when your loan is funded through the lender directly. While indirect financing is when a third party acts as the middleman between the borrower and the lender, for example, a dealership.
Find the Best Types of Car Loans for You
Now you know all the different types of car loans, we hope you’ll have an easier time finding the right car loan for your individual circumstances. Remember to shop around and do your research before jumping into anything.
At CreditSavvi, we pride ourselves on working with hundreds of lenders to find the best deal for you. You can apply for funding with us online and get your quotes quickly, so you can get on with your day!