Vehicle loans are a part of the equation in the vast majority of new and late model used vehicle purchases. Interestingly, consumers will spend days shopping vehicle prices, yet many do not give any thought to shopping for auto loans. Comparison shopping and pre-qualifying for an auto loan should be the first steps you take when buying a car, not the last. Failure to do so can be costly, as financing is one of the most frequently missed car buying opportunities. An auto loan is a unique part of the buying equation and it requires that you focus on it as a separate issue. Reduce your monthly payment by just $16.70 and you will save $1,000 (on a 60 month auto loan). There is no great mystery to auto loans, if you purchase new or late model used vehicles, you are quite familiar with them. Nonetheless, it is important to understand the main components of an auto loan.

The five elements covered in this sub topic are the basic parts of an auto loan. Understanding them and how they relate to each other will help you to effectively shop for an auto loan.

Annual Percentage Rate (APR): The Annual Percentage Rate (APR) is a yearly rate of interest that includes all of the fees and expenses paid to acquire the loan. Federal law requires lenders to disclose the APR. The APR is essentially the ONLY rate you will need to compare one loan (of the same length) with another, because it includes all of the costs associated with acquiring the loan. This makes it very easy for anyone to compare most loans.

Down Payment: The down payment is the total amount of money that the borrower puts down towards the purchase of a vehicle at the time of purchase and origination of the loan. This does NOT include any credits for trade equity or rebates and incentives.

NOTE: The down payment is credited to reduce the final sales price of the vehicle AFTER it has been adjusted to reflect taxes, trade inequity or any other expenses. Many people forget to factor this in when developing a budget and other additions are made to it -- the principal, NOT to the final sales price.

Interest Rate: The interest rate is a part of the APR equation. Interest is the annual rate of return that the lender receives on the Principal of the loan. The interest rate is really relevant to the lender, while the APR relevant to the borrower. This is how the lender determines how much they are making on the loan.

The interest rate is also the cause of more confusion about auto loans than any other single factor. People tend to compare the interest rate when they should be comparing the APR. We have included this definition primarily to try and clarify the difference between interest rate and in an attempt prevent any confusion.

REMEMBER: --The "INTEREST RATE" is primarily relevant to the lender. --The "APR" is primarily relevant to the borrower.

Loan Term: This is the length of the loan, usually broken down into months (24, 36, etc.). While it is true that the longer the "Loan Term", the lower the monthly payment, increasing the length of the loan to lower the monthly payment should be done with a great deal of caution. Getting the lowest APR is the "Golden Rule" of auto buying, not simply getting the lowest payment is the primary concern when shopping for an auto loan.

While many people increase the length of their loan to get a lower payment, we do not usually recommend it. This leads to more debt, substantially more interest and frequently, a trade inequity if the vehicle is traded in during the first three years. If you are more likely to prefer low monthly payments, a low down payment and driving a more expensive vehicle than you might normally be able to afford, leasing may be a better option for you. You can learn more about this option by checking out our leasing section.

Principal: The amount of the auto loan, without the interest factored in. In other words, the amount you are financing, the amount that you WILL be paying interest on. This is arrived at in the following way:

Determine the vehicles final sales price: ADD all relevant fees (taxes, titling obligations, trade inequity, etc.) SUBTRACT amount of down payment (if applicable) SUBTRACT any trade equity (if applicable) SUBTRACT any rebates or incentives (if applicable)

The number that you reach after this process will be the principal. This process may vary slightly from state to state, based on how the final sales price is determined for that particular state (vehicle) sales taxes. MOST states tax on the sales price prior to any reductions (the highest amount). SOME states will allow the final sales price to be reduced by equity of the trade to PRIOR to determining the (vehicle) sales tax.