A car loans is a type of installment loan used to buying a vehicle. It’s a legally binding agreement between you and the lender that says they’ll give you the funds to buy a car, and in return, you’ll pay back the entire loan amount along with any interest by a specific date.
Buying a car involves a weighty amount of investment! Before finalizing a car, you should do thorough research on numerous car models, their features and mileage, and lastly, the mode of finance. Most people prefer a car loan rather than dipping into their savings, irrespective of whether it is a brand new car or a used one.
Key terms to know how car loans work
Before applying for a car loan, you should be accustomed to these terms and what they mean.
- Annual percentage rate: APR is the amount you pay each year to borrow money, including any lender fees, and it’s expressed as a percentage. The APR you receive will be based on several factors, with the most important being your credit history and credit score.
- Loan term: The length of time you have to pay off the loan. Loan terms are in 12 month increments, with the most commonly at 24, 36, 48, 60, 72, and 84 months. NerdWallet recommends no longer than 60 months for new cars and 36 for used cars. The longer the term, the more interest you’ll pay over the life of the loan.
- Interest rate: Similar to APR, but without loan fees included. Since fees can vary from lender to lender, you should use the APR when comparing loan offers for a more accurate comparison.
- Principal amount: The amount of money you originally agreed to pay back. It doesn’t include interest.
- Amortization: The process of paying off your loan that sends a portion of your payment toward principal and an amount to interest. Early in your loan, a higher percentage of your compensation goes to interest. Later, more of your payment will be applied to the loan principal. Because of this, your principal will decrease more quickly toward the end of the loan. (Here is an auto loan amortization calculator to estimate your current balance.)
Here are some additional key terms for car loans
- Down payment: The amount you can pay truthfully toward the car’s price, lowering the amount of your loan.
- Taxes and fees: Additional costs rolled into the total price of your car, such as state sales tax, a documentation fee, and possibly other dealer charges.
- Loan-to-value ratio: The value of your car compared to the loan amount. Because auto loans are secured with the vehicle as collateral, a car’s loan-to-value balance or LTV is a way for lenders to measure their own risk when approving a loan. LTV is calculated with this formula: Loan amount/car value x 100 = LTV. The LTV can affect your loan rate and whether you are approved for a loan.
Benefits of Car Loans
There are many benefits to getting a car loan, including:
You can buy a car now. If you don’t have the cash to buy a car outright, a car loan can help you get the car you want now.
You can build your credit. Making timely payments on your car loan can help you build your credit history, which can make it calmer to qualify for other loans in the future.
You can get a lower interest rate. If you have a good credit score, you may be able to get a lower interest rate on your car loan. This can save you money in the long run.
You can get a longer repayment term. If you have a tight budget, you may be able to get a longer repayment term on your car loan. This will make your monthly payments lower, but you will pay more interest overall.
You can get a variety of loan options. There are many different types of car loans available, so you can find one that fits your needs and budget.
You could lose your car if you default. If you don’t make your car loan payments, the lender may repossess your car.
You could pay more in interest. If you have a high-interest rate on your car loan, you will pay more in interest over the life of the loan.
You could be upside down on your loan. This means that you owe more on your car loan than the car is worth. If you sell the car, you will have to pay out of pocket to cover the difference.
In conclusion, car loans can be an excellent way to finance the purchase of a car. However, it is essential to weigh the benefits and risks before you decide if a car loan is right for you. If you do decide to get a car loan, be sure to shop around for the best interest rate and terms.