Most people today need a loan when they buy a new or used car. And the high cost of many cars means that consumers spend years paying for their vehicles. Because a car loan is such a huge debt for most people, it pays to understand it before entering into an agreement.
A car loan is a secured loan, which means the vehicle serves as collateral on the debt. If you fail to make your payments, the lender can seize it as payment. This is much safer for the lender than unsecured debt, such as a credit card account, where the lender has only the card-holder’s promise to pay.
Car buyers have a number of potential sources for loan cash :
Banks. Getting financed through a bank is typically the easiest route because commercial and private banks have large pools of capital. A bank could be your best bet if you are looking for the lowest interest rate. Banks can also be a quicker and more convenient source for car loans because they are structured to make a large number of transactions in a short period of time.
Credit Unions. These nonprofit organizations can offer competitive interest rates, but you need to be a member to utilize their services. Criteria for membership varies, but credit unions may focus on people who work in specific industries, live in a certain area or belong to a particular group.
Car Dealerships. Car dealerships offer financing to help sell cars. They often have established relationships with lenders, which can help you get a loan quickly and without a lot of legwork on your part. Keep in mind, however, that dealers typically make a considerable profit on loans, so it pays to understand the interest rate and other terms being offered.
Home Equity Loans. These are an alternative to a traditional auto loan. Financial institutions often lend money to borrowers based on the equity in their homes. This money can be used for many purposes but a popular one with many borrowers is buying a new or used vehicle. One particularly attractive feature is that interest on these loans is typically tax-deductible.
Types of Auto Loans
Not all car loans are alike. Here are two typical kinds of loans offered on new or used vehicles :
Pre-Computed Loan. With this type of financing, interest and principal payments are pre-calculated before the borrower and lender agree and sign the paperwork. This loan was widely used in the past. Because it doesn’t allow for early repayment of the loan, most people don’t opt for this restrictive method of financing.
Simple Interest Loans. This is the most common type of financing offered. The interest rate is based on the outstanding balance of the loan, similar to a credit card. Borrowers can save on interest costs by paying more than their standard monthly payment.
What About Leasing ?
As car costs have risen, leasing has become a popular alternative to buying. In recent years, leases have comprised more than 30 percent of new vehicle transactions.
On the surface, leasing and buying with a loan may look similar. Both involve payments over time. But what you are buying is different.
With a car loan, you eventually will pay off the loan and own the car. Your payments end and you have the option of keeping the car as long as you like — or as long as you can keep it running.
With a lease, you likely will have a lower down payment, lower monthly payments and lower maintenance costs compared to taking out an auto loan. This is part of the appeal of a lease.
However, at the end of the lease you do not own the car. At this point you have two options: buying the vehicle, which can require taking out a loan, or beginning a whole new lease.
Other Car-Related Loans
Economic conditions in recent years have focused attention on other types of car-related loans. People who took out loans when interest rates were higher can seek out refinancing at banks and other lenders to lower their borrowing costs. The down side is that the new loan, though easier to pay, may extend the number of years the borrower needs to make payments.
Much more risky is borrowing money based on equity in the car you already own. These “car-title loans” mostly appeal to people who have fallen on hard times and need cash they cannot borrow elsewhere. Interest rates on these short-term loans can be sky-high, and a borrower who fails to pay can find himself deeper in debt and at risk of losing his car.
Al Krulick