Buying a car usually means applying for a car loan. If you're looking for a new car, you've probably spent a lot of time researching car options, but do you know enough about how car loans work? When you take out a car loan from a financial institution, you get your money in one payment and pay it back (plus interest) over time. How much you borrow and how long it takes you to pay off your interest rate can all affect your monthly payment amount.
A car loan is secured by the vehicle you intend to purchase, which means that the vehicle serves as security for the loan.
A car loan is secured by the vehicle you intend to purchase, which means the vehicle serves as collateral for the loan. The lender can seize the car in case of default. The loan is repaid in fixed installments over the life of the loan. Just like a mortgage, the lender retains ownership of the asset until you make the final payment.
A car loan is money you borrow from a bank, credit union, car dealership, or online lender to buy a new or used car.
Auto loan debt, plus fees and interest, is paid off by making regular payments over a set period of time. If you are unable to repay your loan, the lender can repossess the car to pay the remaining balance.
Generally, to obtain a loan for the purchase of a car (sometimes called auto or vehicle financing), you apply for a loan (or possibly a line of credit) from your financial institution or choose a financing plan offered by a car dealer at the time of purchase.
Loan amount:
This can be much less than the value of the car depending on whether you have a trade-in vehicle and/or pay a deposit.
Annual Percentage Rate:
Often referred to as APR, this is the actual interest rate you pay on the loan.
Loan term:
This is the time you have to repay the loan, usually 36 to 72 months.
One of the most important things to understand about how a car loan works is the relationship between the term of the loan and the interest you pay. A longer loan term can significantly lower your monthly payment, but it also means you pay more interest.
Consider a $25,000 car loan at 3.00% APR for 48 months.
During the 4-year repayment period, you paid a total of $1,561 in interest on the loan. If you extend the term of the same loan to 60 months (or 5 years), your monthly payment would decrease by $104, but your total interest payment would increase from $1,561 to $1,953.
Some people may choose to lease rather than get a car loan so that you can buy the vehicle and eventually own it entirely.
Renting a car is like renting a car - but for longer.
You don't own the car, but you can drive it during the lease. During this time, you make monthly payments and are responsible for maintenance fees.
At the end of the lease, you can choose to return the car to the dealer and drive away - as long as you stick to the terms of the lease, otherwise you risk a fine. Conditions may include annual mileage and excess wear and tear charges.
Leasing a car instead of buying one with a car loan can mean lower monthly payments and the chance to get a new car every few years.
However, you won't build equity in your car and could face hefty fines if you go over the agreed mileage or if the car shows more wear than the dealer considers "normal".
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