Understanding Auto Finance Solutions

Purchasing a vehicle can be a pretty overwhelming experience. As if shopping around for a car isn't exhaustive enough, there's a separate--and sometimes equally exhaustive--process involved with securing an auto finance solution. By understanding the process and terminology associated with obtaining a car loan, you're less likely to overlook an important detail or end up with a loan that doesn't fit into your budget.

Following is a list of words and phrases you're likely to encounter:

• Term. The term of a loan is simply the amount of time you're given to pay it back. Term lengths generally vary from three to five years, with a handful of lenders offering terms of up to seven years. Just remember--while longer terms mean lower monthly payments, they also mean more interest payments that end up taking more of your money in the long run.
• Interest Rate. The interest rate, which is a percentage of your total loan amount, is the fee a charged by a lender for its services. The rate could vary depending on your credit history, and the total amount of interest you pay will depend on the length of your term. Therefore, when comparing two auto finance solutions, identical interest rates aren't always equal. Make sure you take into consideration each loan's term and all additional charges.
• APR. The APR, or annual percentage rate, is a breakdown of the amount of interest and other finance charges you'll pay on a yearly basis. Lenders are required by law to provide an APR with each estimate so borrowers can more easily compare loans.
• Down Payment. A down payment is the amount of money you can afford to pay up front. While some auto finance solutions don't require a down payment, it's always in your best interest to come up with one. The bigger your down payment, the less you'll have to borrow. The less you borrow, the lower your monthly payments will be. A bigger down payment might even get you a lower interest rate.
• Yield-spread Premium. Often found in loan contracts obtained through dealerships, a yield-spread premium is a fancy name for interest that's added onto the rate you were quoted. This extra money is pure profit that benefits the dealer and the lender, but leaves the customer with a more expensive loan.
• Collateral. In all types of loans, collateral is something of value that the borrower offers as a guarantee that the money will be repaid. Although you don't have to come up with an existing asset to secure an auto finance option, there is collateral involved in the transaction: your new vehicle. Until the loan is satisfied, the car technically belongs to the lender, who can--and will--take possession of it if you ever default on your loan. Not only would that leave you without transportation, but it also severely damage your credit score. That's why it's important to make sure you can afford the monthly payments before taking the plunge.