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Buying a car can be intimidating. For many, it’s the second-largest purchase they’ll ever make (the first usually being their house). For this reason, many choose to finance their cars.
But with so many different types of auto loans out there, it can be hard to know which one to choose. So let’s break down seven types of car loans so you can make a more informed decision.
Secured vs. unsecured auto loans
First, you need to understand the difference between secured and unsecured auto loans. A secured auto loan is one in which the vehicle serves as collateral. So if you stop making your payments, the lender is allowed to repossess the car. To qualify for a secured loan, your vehicle must typically also meet certain requirements.
Another type of secured loan is a HELOC (home equity line of credit). It’s a line of credit secured by your house, which allows you to get a better interest rate. Plus, you get to deduct the interest on that loan from your taxes, which you can’t generally do with a car loan.
In contrast, an unsecured loan is one that isn’t tied to any assets. If the borrower stops paying, the lender must try to recover their money through legal means other than repossession. Consequently, unsecured loans tend to cost more in terms of interest rates and origination fees. You can learn more about towing a car (Hinaaminen).
Simple interest vs. precomputed interest auto loans
The distinction between interest and precomputed interest auto loans is another one you should know. With simple interest, a large portion of your first payments goes toward paying off the interest of the loan, not the principal. The flip side is that by the end of the loan period, the interest is mostly paid for and you’re mostly paying off principal at that point. You can also reduce the amount of interest paid if you repay your loan early.
Precomputed interest auto loans are less common and work like this: All the interest, loan balance, and origination fees are calculated at the beginning and spread out evenly across the loan term. This means you pay an equal amount of each on every payment. However, it’s hard to reduce the total cost of the loan, so there’s no incentive to pay it off early.
That said, if you make your payments on time for the entirety of the auto loan, there is little difference between these two types of loan structures in the long run.
Direct vs. indirect vs. in-house auto loans
Finally, there are direct, indirect, and in-house car financing loans. Direct financing refers to when you get a loan directly from a lender, such as a bank or credit union. All the communication is directly with them. If you go this route, you can even secure a loan before you ever go to a dealership. Ask for quotes and shop around to get a better idea of what you can afford.
With indirect financing, the auto loan is administered by the dealership. They shop your loan out to the same types of lenders that you could go to on your own. But in this case, you work with the dealership, which serves as an intermediary.
Lastly, in-house or buy here, pay here (BHPH) financing is when the dealership has its own auto loan products. They become the seller and the lender. Often, BHPH dealerships cater to those who can’t qualify for traditional auto loans. According to Tiger Okeley at BHPH dealership Oak Motors, “BHPH is a great option for young buyers who may not have built up a strong credit history yet.”
The bottom line
There are many types of auto loans out there, and we’ve just barely scratched the surface. You can even refinance car loans by replacing old loans with new ones. Usually, people do this because interest rates go down or their financial situation improves, allowing them to get better loan terms.
Now that you know what some of your car loan options are, you’re better positioned to choose the one that best fits your needs.
