About Car Loans
Car loans are like most other loans. The borrower agrees to repay the amount of the loan, plus interest, over a period of time. With a car loan, the car itself is collateral for the loan. If the borrower does not make timely payments, the car can be repossessed by the lender.
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Function
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A car loan allows the car buyer to purchase a vehicle without having all of the money for the purchase price. For the lender, a car loan provides profit in the form of interest payments. For the car seller, a car loan allows the dealer to sell automobiles to more people than might be possible if buyers had to pay cash up front.
Time Frame
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Car loans come with many repayment periods. Generally, the buyer may choose the repayment period so long as it does not exceed the lender's maximum loan length. Car loans of up to seven years on new cars are common. Longer terms can be found among certain lenders.
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Features
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A car loan has three main features. The first feature is the loan amount. This represents the purchase price of the car minus any down payment plus any taxes, fees and insurance that the buyer agrees to include in the loan. The second feature is the interest rate. The rate determines the eventual cost of the loan. The third feature is the repayment schedule. Traditionally, car loans require monthly payments that are calculated so that the balance of the loan is zero at the end of the repayment period.
Considerations
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The payments required for a car loan can often eat up a significant portion of a household's monthly budget. Thus, a car loan must be considered carefully before purchasing a car. In addition, the longer the loan period, the lower the monthly payment, but the higher the total repayment amount. Also, with longer the loan, the more likely the borrower may be "upside down" in the car, meaning that the amount still owed on the car exceeds it resale value.
Benefits
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A car loan can provide a way for a buyer to purchase a car that he could not pay cash for. This can be especially beneficial for parents who require a bigger, safer car than they could otherwise afford.
Warning
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Car loans available from the dealer selling the car do not always represent the best deal for a buyer. It is important to shop around prior to entering into a car loan. This is particularly true for buyers with low credit, or buyers with credit that borders on the highest level. One car loan may consider those with credit scores above 720 to be qualified for the best rate, while another loan may require a score of only 700. Thus, it is important to compare actual rates available and not just the best rate that is usually posted on the sign or website.
Expert Insight
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Beware of using car loans to purchase a car that is too expensive for you. If your mortgage payment is $2,000, does it make sense for your car payment to be up to 40 percent of that? Do not use longer loan terms to get into a more expensive car. If you ever need to sell your car for financial reasons, a longer term loan will leave you with much less equity, or upside down, in the car.
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