The Different Types of Car Loans: How to Choose the Right One for You

Shopping around and looking for car loans is an overwhelming process. Sometimes, lenders often use industry-related jargon and language that you may not understand.

Buying used cars is one of the most common practices in America. Most used car purchases happen in private, and the buyers often prefer paying in cash. However, it can be quite challenging to buy a new car in cash.

That’s why most Americans prefer taking out car loans to finance their purchases. According to research, the outstanding car loan debt in the U.S is almost $1.2 trillion. While aspiring car owners are fast to send in loan applications, most people don’t know the various types of vehicle loan options available.

If this is your first time shopping for a car loan, ensure you know the different types of loans. This will help you know the ideal loan type to help you finance your car purchase. Below are the different types of loans available to you:

Secured Car Loans

Most lenders offer secured car loans. A secured loan means that it is assured or guaranteed by an underlying asset. For example, a secured vehicle loan is guaranteed by the car as it acts as collateral.

If you cannot repay your car loan, the lender may legally repossess or seize the car. That is because your lender is legally listed as the lienholder on your car’s title, and you don’t have full ownership yet. However, after paying the loan, the lender will no longer have the right to repossess your car, and the lien will be lifted.

Secured loans are riskier for the borrower and present a lower risk level for the lender. Thus, this type of loan tends to have a lesser interest rate than other loans on this list.

If your primary concern is to find a car loan with the lowest interest rate in the market, ensure you get a secured car loan. However, always remember that other aspects may influence the interest rate. These factors include the loan term, your credit score, and your income.

Below are different types of secured car loans:

Balloon Loans

A balloon loan has a distinctive repayment structure. The borrower makes payments in smaller amounts within the first several months of the loan term. A larger payment amount follows these small payments at the end of the loan term.

The loan term may last between 35-60 months, and you may pay the larger amount towards the end of the loan. This is why the loan is known as a balloon loan. You could make the final larger payments, sell the car or trade it for a different item.

A Traditional Car Loan

A traditional loan is a regular loan you can get from financial institutions and banks. A lien guarantees the loan on your car’s title. Traditional loans apply to used and new car loans.

A traditional loan will help you get the best interest rates based on your credit score and income when buying a new car. However, you may get higher interest rates when buying a used car.

Fleet and Business Car Loans

In today’s world, everyone needs a car. This includes small and mid-sized businesses as well as government entities. However, you can’t use a traditional loan to purchase a vehicle for an agency or commercial use.

Depending on the type of business you run and the type of car, you could qualify for a business car loan. For example, you can opt for a commercial truck loan, a fleet loan, or a small business car financing option.

Unsecured Car Loan

Unlike a secured car loan, an unsecured loan does not rely on any collateral or lien. Thus, it’s not guaranteed by any underlying asset, including the car itself. Instead, the lender relies more on your promise to pay back the loan.

Legally, the lender isn’t allowed to place a lien on a car that’s financed with an unsecured loan. They also can’t repossess or seize the car if the borrower fails to pay the loan.

Thanks to the greater risk that unsecured car loans pose to lenders, their interest rates are higher than other loan types. However, your exact car loan interest rate will depend on the lender, your credit score, and your ability to pay back the loan.

A Simple Interest Car Loan

A simple interest car loan is designed so that the outstanding loan balance periodically accumulates a specific interest rate. Most simple interest loans accumulate interest every day. Most lenders prefer borrowers to make payments every month.

However, you can also accelerate the loan payoff to help you reduce the interest rate acceleration. You can do this by increasing your monthly payment amounts and reducing your outstanding principal. Therefore, a simple interest loan is the best option for borrowers looking for a flexible loan as it allows you some breathing space.

A simple interest loan is also great for individuals expecting an increase in cash flow, perhaps from reduced household expenses or a salary increase from work. Getting a simple interest car loan will reduce your borrowing expenses.

Pre-Computed Car Loans

A pre-computed car loan does not offer the same level of flexibility as simple interest car loans. The borrower is supposed to make pre-planned repayments based on predetermined timing. The interest rate is also pre-determined, and each repayment amount is allocated a specific portion of your loan’s interest and principal.

Unfortunately, accelerated payments will not lower your loan’s interest and principal during the loan’s term. However, it will frontload your total payoff.

If you expect any negative changes to your finances or are operating on a limited budget, a pre-computed loan is the best option for you. It will give you a more predictable repayment schedule.

Pre-computed car loans are considered illegal in some states. That’s because they are not flexible and don’t offer borrowers an opportunity to reduce the interest rate. Thus, it’s only advisable to get this type of loan if you are sure you will never increase your monthly repayments.

Title Car Loans

This type of secured loan is reserved for individuals who prefer owning their cars outright. It works like a house equity loan, as it allows you to leverage the car’s value when borrowing the loan.

After getting the loan, your lender will place a lien on your car, taking possession of it until you repay the full amount. While you will be using the vehicle, the lender may repossess it if you become delinquent.

A title car loan is the best option if you cannot get an auto loan from other financial institutions and banks due to bad credit. That’s because the lender will not check your credit before approving you for the loan.

Lease Buyout Loan

At the end of your car lease, you often have two choices: purchase or return it to the owner. Unfortunately, if you choose to purchase the vehicle after the lease term, it will not qualify for a lower-interest-rate loan. That’s because it is already used, and lenders aren’t quite sure about its conditions.

A lease buyout loan helps you finance the purchase of the car after the end of your lease term. However, a lease buyout loan is riskier to lenders, making its interest rates quite high. Unfortunately, very few lenders offer lease buyout loans.

A private Party Vehicle Loan

Purchasing a used vehicle from a private entity is better and cheaper than buying from a dealer. However, private-party loans come with numerous disadvantages. For example, although numerous credit units have the same interest rates for both new and used car loans, these include increased car loan rates.

When you buy a vehicle directly from an individual instead of a dealer, it is difficult for the lender to know whether it is in good condition. However, numerous states don’t offer any consumer protection for people who buy cars from private people. Thus, such a deal is risky for the lender.

Direct and Indirect Financing

A direct financing option is when you obtain a loan directly from the lender. On the other hand, an indirect loan is when you go through an intermediary or a third party, like a dealership, to help you with your loan application process.

Today, most consumer lenders and financial institutions act as both direct and indirect lenders. For example, you can walk into a bank and talk to them about your car application, and you could go through a dealership with connections to the bank.

Now You Know How to Choose the Best Car Loan for You

There are many car loans in the market for consumers and businesses today. Every car loan is different, and understanding the different options you have will help you make an informed decision and choose the best loan for you. When applying for a loan, remember to check the loan duration, interest rates, APR, credit score, and loan fees.

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