Understanding Car Loans: A Beginner’s Guide
Most people today finance, a smaller percentage lease, and even fewer pay cash; but this is not indicative of which option is best, as each has its own set of advantages and disadvantages. The specifics of your purchasing method are highly dependent upon certain details, such as how long you wish to own the vehicle, how costly you want your monthly payments to be, and how much cash you have on hand. Regardless of your approach, the ins and outs of an auto loan need to be clear to both lender and borrower.
Before diving into auto loans for financing a new or used vehicle, it’s a good idea to get a handle on the three major methods of buying a car:
Cash: A positive to this method is a lack of worry over charges or finance fees; also, when using cash, you hold the title (rather than the bank keeping it), making for less hassle if you choose to sell the vehicle later down the road. Most importantly, you do not have to make monthly payments. A negative aspect of paying cash is that people most often don’t have such a large sum of money stowed away.
Leasing: This option usually allows for a new model annually, and the vehicle is typically kept under warranty, eliminating worry over engine or other performance problems. The monthly leasing payments are often less than financing. Additionally, there are highly beneficial tax cuts when the leased vehicle is used primarily for business purposes. When leasing, you do not have to worry about making a down payment—assuming your credit is good enough. Negative aspects of leasing include requiring more than having basic insurance–often dealerships will require a specific amount or a specific type of insurance, resulting in a higher monthly fee. Also, although a leased vehicle is covered with a warranty, it is not covered for scratches and dents, which will have to be paid out of pocket.
Financing: The most commonly used method of purchase for Americans, this option allows you to use the bank’s money, freeing up your disposable income and the time it can take to save enough money to pay cash. Credit scores determine the type of financing available (the higher the score, the lower the interest rate), and there are usually nice warranty packages available for financers. The downside to financing? Your monthly payments are usually a little higher than when leasing, and there is usually a hefty down payment required.
The Skinny on Car Loans
Vehicle loans are considered secure personal loans, since the car you are purchasing will be collateral. Under this type of loan, the lender will make an agreement with the buyer to finance your purchase under a specific set of conditions. The loan you receive will be the allotted amount needed to buy the desired vehicle and you will be required to make regular payments over a pre-established period of time.
Here are the details:
- The Terms and Conditions
The terms and conditions for your auto loan explain exactly what amount is going to be borrowed, the term length (how long you will be making payments), the interest rate of your loan, the down payment amount (if there is one), the insurance requirements, and detailed instructions for paying off the loan, including information on the penalties (if any) for paying off prior to the end of the term length.
The terms and conditions are usually the fine print, you know, that bit most of us tend to ignore, but we recommend not skipping this part. Always read the fine print when it comes to auto loans so you are sure to understand everything you are agreeing to–for instance, it would be good to know if there is a penalty for paying off the loan early, especially if that is what you hope to do.
- APRs vs. Interest Reates
The interest rate on a loan is how much your lender will charge you for borrowing money from them to pay for the car. These rates are also listed as an APR, or annual percentage rate. This number includes the additional fees to figure the overall interest rate being paid. When looking at these two numbers focus on the APR, as it tends to be more accurate in its representation of what you will truly end up paying over the span of your loan. Use this number when comparing loans from different lenders (you obviously what this number as low as possible).
- A Down Payment
When you pay any amount of money upfront towards the purchase of your new or used car, this is called a down payment. Oftentimes, you can trade in another vehicle instead of using cash for your down payment, or, even a mix of the two, cash and a trade-in. Down payments–in any form–are considered as a percentage of the total purchasing price.
For instance, making a down payment of $6,000 at the time of purchase is considered a 20% payment for a vehicle listed at $30,000, leaving you with $24,000 remaining on the loan.
- The Principal Interest
Once you know how much money you will be borrowing (after your down payment), and you know the term length of your loan, you can figure the principle and interest payment. So if after everything is negotiated, and you end up with a loan of $2400, here is what the monthly principal (amount borrowed) and the interest (amount it costs you to borrow the money) payments at three different interest rates would be:
- 5% APR for 48 months is $552.70
- 5% APR for 60 months is $452.91
- 5% APR for 48 months is $558.16
- 6% APR for 72 months is $397.75
Though these examples are a bit random, clearly longer terms lower the monthly payment amount, but in the long run you will pay more this way. Continuing with the examples above:
- 5% APR for 48 months equals $26,529
- 5% APR for 60 months equals $27,174
- 5% APR for 48 months equals $26,791
- 6% APR for 72 months equals $28,638
Keeping in mind that the original payoff amount after the down payment was $24,000, you will end up paying up to $4,000 more than the original price of the vehicle in these examples. Choosing the duration of the auto loan can be a tricky decision, but it basically comes down to you paying more now and less overall, or paying less now and more overall.
As mentioned, some lenders charge prepayment penalties for those wanting to pay a little more in order to get out of the loan quicker, which is why it is recommended you shop around and try to find one that doesn’t enforce this penalty. In this case, you can get a longer term (some go up to 84 months) with a lower monthly payment then up your payment amount once you are able.
Regardless of what you decide, or if you have any questions about the details to obtaining an auto loan, give us a call at 704-708-8000 and we will help figure out which option works the best for you.