Crunching the Numbers: Comparing Car Loans Before You Buy

If you’re in the market for a car loan, it’s essential to understand your options. From deposit amounts and loan terms to interest rates and fees, lots of factors can influence the availability and costs associated with auto loans. Whether you’re purchasing a new car from a vendor or buying a second-hand vehicle in a private sale, making smart decisions from the outset will help you to save money down the road.

Let’s look at car loans in the United States and how to compare numbers and options to ensure a great deal.

What are car loans and how do they work?

For most people, buying a car is a huge purchase decision that involves borrowing money. A car loan is a simple arrangement between one party who acts as the borrower and another party who acts as the lender. You borrow money in order to buy the car and enter into an agreement to pay back the funds over a set period of time. Along with the initial capital, the vast majority of loans involve interest, which is the price you pay for loan access. Most loans also involve fees, including one-off fees when the agreement is signed and ongoing fees throughout the loan term.

Key components of a car loan

While auto loans are simple in theory, making the wrong decision can be costly and hard to reverse. Before you take out a car loan, it’s important to understand the following elements:

  • Down payment – This is an initial payment made at the start of a loan agreement. While this upfront cost is not part of every loan arrangement, it is extremely common. A down payment is typically 20% or more of the car’s loan value, paid in cash as a vehicle trade-in or a combination of both.
  • Interest rate – This represents the ongoing cost of getting a loan, and this amount needs to be paid back to the lender in addition to the value of the car. The higher the interest rate, the more expensive the loan. When it is called the annual percentage rate (APR), it also includes ongoing fees as a yearly percentage.
  • Loan term – Also known as the loan duration, this is the time it takes to pay back your loan. There is a clear relationship between the loan term, monthly payments, and interest. While a longer loan term means lower monthly payments, you will end up paying more money in interest over time.
  • Principal vs. total cost – The principal is the amount that you borrow minus interest, fees, and other costs. The total cost is the total loan amount over time, including the value of the car and the price you pay for borrowing money. When comparing loans, the total cost is a more accurate indicator of the real cost.

Who issues car loans?

In the United States, car loans are available from multiple parties, with pros and cons associated with different providers and their products. Finding the right lender for your individual situation is central to every good arrangement. Most lenders can be split up into the following four categories:

  • Family and friends – You may be able to borrow money directly from your friends or family members. While this is not always possible, it does provide a number of advantages over commercial loan arrangements. Borrowing funds from people you know is often cheaper due to a lack of interest payments, and loans can be more accessible because down payments are not always required. However, borrowing from friends and family can lead to relationship problems.
  • Dealerships – Commercial vendors may offer dealership financing, among other options. Depending on their size and location, car yards may have existing relationships with multiple lenders. While this can make it easy to obtain finance, going down this road can be expensive and risky. You should try to avoid “buy here, pay here” offers aimed at people with bad credit or no credit history, as they often involve high interest rates and fees.

  • Mainstream banks and credit unions – Direct lending is available from traditional banks and credit unions, and it provides a number of advantages. Big banks and credit unions lend money every day, most of which are in a great position to offer competitive interest rates and fees. However, flexibility is not their strong suit, which can be a major disadvantage to anyone with a compromised credit history.
  • Community-based financial institutions – Smaller credit unions and community-based financial institutions are a great option for most people, where easy loan access is combined with competitive interest rates and low fee structures. Some smaller lenders have specific programs for people with bad credit scores or no credit history whatsoever. While the interest rates on offer are not always as low as mainstream banks, there are plenty of great deals available.

How to crunch numbers and compare car loans

Once you understand the basic elements of a car loan, you can start to compare loans based on the information available. Regardless of the service you use, car loans are typically paid back in monthly installments over the term of the loan. Your chief consideration as a potential borrower is to balance out the loan term with the interest paid over time in order to set up the ideal monthly payment structure for your needs.

  • Longer-term loans are likely to make your monthly payments lower — at the expense of higher interest payments and a greater total cost over time.
  • Shorter-term loans are likely to make your monthly payments higher — with the advantage of lower interest payments and a lower total cost over time.

Like many things in life, you need to weigh up short-term and long-term pain to find the best solution for your lifestyle. It’s not quite that simple, however, as interest rates also play a very significant role. Interest rates are set as a percentage term, functioning independently regardless of the term of the loan. For example, if you have a 5% interest rate, you pay that much interest regardless of the loan term.

  • Higher interest rates make your monthly payments higher, which leads to a greater total cost over time.
  • Lower interest rates make your monthly payments lower, which leads to a smaller total cost over time.

When you understand these details, comparing car loans can be easier than you think. With the following four elements, you can work out how much your loan will be and what you need to pay back each month.

  • The cost of the car
  • The down payment amount
  • The term of the loan
  • The interest rate

When you subtract the down payment from the cost of the car, you have the total cost of the loan. When you divide this amount by the term of the loan, you have the principal payment per month. When you multiply this amount with the interest rate, you have the final payment per month, which is what you need to budget for each month over the term of the loan.

Information you need before applying for an auto loan

In order to get a car loan, you’ll need to provide lenders with some information. While you need to complete a loan application, and lots of paperwork is involved, this process is relatively straightforward. Basically, the entity lending you money wants to get an accurate overview of your current financial situation and history. They need to know how much you can be trusted with and how likely you are to make repayments in the designated time period.

In order to check your current financial health, they will look at your employment records and bank statements to balance your income with your debt. In order to check your financial history, they will review your credit score and possibly look at past debt arrangements and records.

In most situations, you’ll need the following information during the application process:

  • Personal identification
  • Social Security number
  • Address — current and past
  • Bank statements
  • Employment income and data — current and past
  • Debt records and information

Auto loans by credit score

Once potential lenders have the information they need, they will start the approval process by checking your credit score and history. Your credit score is affected by open accounts, total debt levels, and historical repayment data. This simple three-digit number is produced by multiple credit reporting bureaus, with two primary credit score systems used in the United States and three prominent credit agencies.

  • Fair Isaac Corporation (FICO) produces the most popular score. This proprietary model pulls data from a number of agencies and situations.
  • VantageScore is a widely used alternative model, which uses data from three credit reporting agencies: Experian, Equifax, and Transunion.

Your credit score is based on a detailed analysis of your borrowing history and credit files, from mortgages and personal loans to utility and cellphone accounts. This score is used whenever someone is thinking about lending you money, from banks and financial institutions to utility companies and retail stores.

In the United States, your credit score is a number between 300 and 850. The following levels are typically applied to auto loans:

  • Superprime credit: 780-850
  • Prime credit: 660-779
  • Nonprime credit: 600-659
  • Subprime credit: 500-599
  • Deep subprime credit: 300-499

It’s important to note that your credit score can affect both loan access and loan conditions. For example, people with a higher score are more likely to be approved for specific car loans and to be offered lower interest rates in equal conditions. 

It’s also important to note that the application process itself can have an impact on your credit score. In most cases, the lender will pull a hard inquiry on your credit, which can cause a small dip in your score.

How do you get pre-qualified for an auto loan?

Before you get approved for a car loan, you can ask to be accepted for pre-qualification. While not a guarantee of approval, this initial offer does provide you with an agreed loan amount and interest rate. Pre-qualification is useful before you start shopping around for a car, as it gives you confidence and provides a bargaining chip at the dealership. In most situations, pre-qualification involves a soft pull of your credit, which means it won’t affect your credit score.

Interest rates for car loans in 2021

Collectively, interest rates change all the time based on the current federal reserve interest rate, the competitive banking environment, and wider economic conditions. On an individual basis, different rates are available based on the type of loan, the type of car, the loan term, and the individual lender. For example, loans for newer cars tend to have lower interest rates, as they carry a lower risk.

According to Experian’s State of the Automotive Finance Market, based on data from the first quarter of 2021, the average car loan interest rate was 4.09% for a new car and 8.66% for a used car. Credit scores can change things dramatically in terms of both loan availability and interest rate offers. For example, APRs can get down to as low as 2.34% for a new car and superprime credit score. On the other side of the coin, they can reach above 20% for a used car and deep subprime credit score.

The DCCU difference

DCCU is a trusted community-based lender offering competitive car loans to people in Madison and the surrounding area. We are 100% committed to the economic and social well-being of our members, so you can rely on honest advice, low fees, and great rates. We proudly help people from a range of socioeconomic backgrounds to overcome the challenges of car ownership. 

DCCU is owned by our members, with our financial cooperative dedicated to “building lifetime relationships through personalized financial service.” Along with easy loan access and great rates, we provide extended warranty protection and auto loan pre-qualification. We serve people in Madison and the surrounding counties of Dane, Columbia, Dodge, Jefferson, Rock, Green, Iowa, and Sauk.

If you want a car loan from a caring community-based lender, please contact DCCU today.



Published by

Jen M.

Jen has been with DCCU since she graduated from UW Madison - a long time ago. As the Content Strategist she helps share all the amazing things DCCU does in our community and spreads the credit union philosophy of People Helping People. When she's not working for the best credit union in south central Wisconsin, she's busy with 4 kids and a feisty little dog at home. She formed her family through adoption and has a deep passion to support foster and adoptive parents and kids. Her favorite place to relax is poolside or in front of the fireplace.