Car loans – for the first time, according to the U.S. Federal Reserve May report, lending for automobile purchases topped the $1 trillion auto debt mark as Americans become more confident in the economic recovery and continue to choose purchases that reflect that confidence. But with all the Fed buzz about interest rates, mortgage lending, credit cards and student loan debt – which also tops $1 trillion! – it’s often the information about auto loans, available for new and used vehicles, that gets overlooked.
Choosing a car is easy enough. Who hasn’t lingered just a minute over that shiny, perfect new car-show model that probably needs to stay on the wish list? And for most people it does, as we focus on realistic expectations that have more to do with our daily commutes, gas and mileage expenses, insurance costs. But just as there is ultimately a car in the mix that meets our needs, there is also a loan that fits best too.
So whether you’re looking to buy a used old beater to drive around town or happily making an upgrade, there are a few things to look for when choosing an auto loan. The first decision is, obviously, how much you think you can afford to pay each month – and how long you want the term of those payments to be.
By looking at your existing debt ratio, you’ll have a better idea of what you can afford before you shop for a loan. And yes, you should shop for a loan! Even if you decide to finance that vehicle through the dealership, you’ll be in a better position to know what the current options are and negotiate from there.
There are a few different ways of measuring your debt load, but here’s the easiest way to think about it: Figure out what your gross monthly income is (divide the annual figure by 12, if necessary) and then see how much of that is already committed to other non-housing debt. Anything above 20 percent makes it more difficult for lenders to approve a loan; more important, it makes it harder for you to carry the loan.
You’ll also want to consider the 28/36 rule used by mortgage lenders. That means that the upper limits of your housing debt should not exceed 28 percent, and your overall debt payments should be no greater than 36 percent. When you know the answers to these money questions, you’ll have a better understanding of how much car you can afford and what kinds of interest rates you might be eligible for.
Keep in mind that your situation is unique, and plugs into these or any other formulas in a unique way too. You may have low income, but no housing or student debt. You may have less-than-perfect credit, but a secure and improved income now that the economy is recovering. All of these factors enter into the options you’ll have for loan products, and ultimately the vehicle that you decide to purchase. There are easy-to-use online tools, such as the Edmunds.com calculator, that can help you see the big picture. It’s information that also will help you decide how reputable the auto dealers and loan providers are, as you evaluate the information they’re providing about different vehicles, sticker prices and interest rates.
This is especially important if you’re choosing a pricier loan because of a higher debt-income ratio. It’s normal to expect to pay higher interest rates, and that makes it even more necessary for you to see what exactly you’ll be paying per month, for how long, and what the real cost of that new car will be.