Car Loans 101

Car Loans 101

Purchasing a car is a huge expense, one that often requires a loan. While securing a car loan is relatively easy, the many steps involved may make it confusing for a first-time buyer. The following is a quick breakdown of the basics behind a car loan.


What is a Car Loan Exactly?

A car loan is a loan specifically for the purpose of purchasing a car and is composed of two parts: the principal amount and interest. Principal is the total amount taken out for the loan whereas interest is accrued on that amount. Some loan terms may require you to pay interest owed on the loan amount, but you may be able to find a 0% financing deal.  


Because a car loan is for quite a large sum of money, paying one back often takes a long time. Thus, car loans are referred to in terms of months, whether that is 12 months of 72. Deciding between a short term plan with high payments versus a long term play with small payments depends on your own unique financial situation.


When to Get a Car Loan?

Interested in getting a car? You may not know, but you should always shop for a car loan before looking for the perfect car. Your bank may offer you a good rate as you are already an established customer. If you are not satisfied with your bank's rate, a credit union is the next place to look. The only drawback to credit union is that you often need to be a member before you can take out a loan. If you are a homeowner you may want to consider taking out a home equity loan in order to pay for your car with cash. 


Lastly, auto manufacturers also provide in-house financing companies, particularly at new car dealerships. These companies are likely to offer you the best rate as they ultimately want you to purchase their brand's cars. If, however, you are looking to purchase a used car, steer away from these companies. For used cars you will likely get a rate that benefits the dealership rather than you. 


How Long to Pay a Car Loan?

There are short term and long term loans. Both have their advantages and disadvantages depending on your financial situation. A long term loan will mean reduced monthly payments but more interest payments. A short term loan will mean less interest but higher payments each month, something that not everyone can afford. The best type of loan is a 0% financing loan, in which case your monthly payment will be the same no matter how many months the loan is. 


Be sure to check what your loan says about buyouts. If you come into enough money to pay off the principal loan, you don't want to be charged an "early payout fee". This type of fee is sometimes included in a loan's terms to make up the loss of the interest that occurs when you pay off the loan ahead of schedule. 


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