How Not To Let Your Car Loan Drown You

More and more customers are seeking extended tenors for their car loans compared to the customary three year financing that was prevalent just some time back. This is because not only an increasing number of customers are buying more expensive cars but also the cost of operating and maintaining a car has gone up substantially resulting in severely straining the customer’s wallet. It is fast becoming a norm for customers to go in for car loan tenors that are six or seven years to make the monthly payments affordable. A recent study by Kelly Blue Book suggests that every six out ten customers purchasing new cars are opting got long term finance.

Car Loan Drown

Hazards of a Long Term Car Loan
While loans that are repaid over a long term have the advantage of a lower monthly payment, usually these are more expensive than short term loans as they carry a higher rate of interest. This is because lenders are exposed to the risk for a longer time, and there is very little to predict how customers will behave over a longer period of time as the prevailing economic conditions are more likely to undergo change. With the tenors being extended the borrower will pay a lot more in interest over the life of the loan than what he would have in case the loan was for a shorter term.

Because the interest rate is high, the interest component of each of the monthly payments is higher than that of the principal. With less of the principal being repaid every month, the chance of the loan becoming upside down is more. This means that the amount owed on the vehicle is more than what is worth at that point of time. This phenomenon of being upside down on the car loan is quite common in the first couple of years but with a loan that extends for a longer period, it is possible to be upside down for a considerably longer period as the value of the car goes down faster than the increase in your equity. If you decide to replace your car before the end of the loan tenor, you could be rolling over the unpaid amount into the next car loan and increasing the chances of being upside down more than before.

How to Lower Monthly Payments without Increasing Your Cost
Instead of getting car finance from the dealership, it is better usually to get a pre-approved loan from a financier like a bank or a credit union, as the interest rate that you would be able to get will be significantly lower. This will automatically lower your monthly payment.

Making a larger down payment also helps in significantly lowering the amount of the monthly payments. With the help of an online calculator, you would be able to see the difference between making a nominal 5% down payment versus upping this to a more reasonable 20%. If you think you can cut back on other expenses and make a heftier down payment you should go ahead and limit the loan tenor to one where you find the monthly payment to be affordable.

If you do not have the requisite savings, look around to see if you can borrow from your family or friends. If you have a home in which you have a substantial equity, you can consider taking a loan against it. While you may also benefit by way of lower interest rates, ensure that you do not put your home at risk.

Read the Fine Print
Most people do not bother to properly checkout the annual percentage rate (APR) that is the actual rate of interest applicable on your loan after tagging on all the other costs like financier charges and fees to the interest rate. When evaluating finance options, the APR is the best way of comparing different plans. Another simple method is to ask the lender what the total of all the payments would be for different tenors; this will allow you to see the difference in the extra payment you would be making across tenors. Make it a point to read all the clauses of the agreement even though the lender may suggest that it is all standard verbiage. Make yourself aware regarding financing fees, credit insurance requirement or even prepayment penalties that could prevent you from paying off the loan earlier or refinancing it.

The key to car loan finance is to get an amount that you can pay off in a reasonably short time period. Consider purchasing a more affordable vehicle instead of exposing yourself for a longer time to a potential debt trap that could ensnare you.

Author bio: Sarah Dunbar is a personal finance consultant who trains car finance executives at leading dealerships such as Ideal Auto USA to offer customers the most optimum loan proposals.