Q: What is a Car Loan?

December 17, 2013 12:53 PM

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A car is one of the largest purchases you are likely to make in your lifetime, aside from a house. Cars can cost tens of thousands of dollars. Unless you are independently wealthy, you will not be able to pay for one up front. Financing options are available, but you usually need to make an initial down payment, followed by smaller regular monthly payments. If you need a car now and don't have the money to make a down payment, you still may be able to get a car loan to finance a vehicle. Before you apply for a loan, you need to be prepared for the financial risks and understand the terms of the loan.

To get a car loan, you typically apply through your bank or credit union. However, you may also be able to apply through your insurance company, place of employment, or directly through the auto dealership. Several factors influence the quality of a car loan. These include your credit history, your current income level, your current debt load, and the amount of the loan you require. Better credit means, as a rule, that your interest rates will be lower. Your current income level could influence the amount you can borrow and the monthly period over which you are expected to repay the loan. In addition, your health insurance and life insurance policies can play a part. They may cover any debt you fail to repay in the event of your death.

One term you'll encounter when applying for a car loan is APR, or annual percentage rate. This is the amount of interest the loan has per year, and it is calculated on a monthly basis according to your remaining balance. For example, if your $30,000 60-month loan is set at 6% APR, it starts out with $150 interest per month, with $429 as the principal. You would have to pay $579 per month to pay it on time. Generally, the lower your APR, the better the offer. Administrative fees, such as closing fees, may also be added to the loan. Be sure that the APR is fixed; you don't want it to suddenly increase after you've started making repayments.

You will also need to consider the total cost of ownership of a new vehicle before taking out a loan. This includes fuel, insurance, maintenance (tires, oil changes, etc.), title, tag, and tax, in addition to the loan repayment. If it is beyond your budget, you should consider a loan with a longer repayment period-thus lower monthly payments-or a cheaper vehicle.

Another factor to consider is whether the loan is secured or unsecured. A secured loan is only made when you offer something of equal value as potential collateral, such as a house or private possessions. Should you fail to pay the loan or go into default, the bank can then liquidate those assets up to the value owed. Unsecured loans may come with higher interest rates. The presence of a cosigner may also help, especially if the person has a strong credit history and a steady income level.

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