Publish Date - September 14, 2022
Author: Moses Mwangi
7 Common Car Loan Mistakes and How to Avoid Them
Owning a car is not only a luxury but also a necessity. However, buying a new or used car isn't that simple. Most people find paying the total amount upfront or making a cash purchase hard.
Owning a car is not only a luxury but also a necessity. However, buying a new or used car isn't that simple. Most people find paying the total amount upfront or making a cash purchase hard. In such situations, it makes sense to avail of a car loan from one of the numerous banks or financial institutions that offers quick approvals and easy terms.
However, there is an opposite side to it too. Many people rush to apply for auto loans without planning or verifying facts. Here are the seven most common car loan mistakes people make and ways to avoid them.
1. Failing to consider your budget
Before taking out any loan, it's essential to review your financial situation and ensure you can afford to pay off the debt. If you fail to plan how to integrate monthly auto loan payments into your budget, you might end up rolling behind on payments. This could cause you to accumulate thousands of dollars in unpaid interest and greatly damage your credit score. Unfortunately, a poor credit score could affect your ability to obtain other loans in the future.
Calculate your monthly budget and determine what amount you can be able to pay as equated monthly installment (EMI). In addition, be sure to include the down payment and the maintenance costs for the car in your calculations.
2. Not knowing your credit score
A good credit score is essential when applying for a car loan since any leading institution will be interested in examining your credit history. If you end up with a bad credit score, there is a high chance of your car loan application getting rejected. However, if you have a good credit score, you can expect to be rendered favorable terms on your car loan.
Examine your credit score before you apply for an auto loan. In addition, keep in mind that you might need to pay the highest interest rates if you take a car loan with a bad credit score. If your credit score is low, consider taking time to improve it to get a better interest rate.
3. Only considering the monthly payment
Your monthly payments should fit into your budget. However, focusing solely on the monthly payment is one of the grave mistakes you can make when getting a car loan. This can not only get you tied into a car loan that is years more than you should get, but a dishonest car dealer can pack expensive additions into the financing package.
When taking out a car loan that will probably span between 5 and 7 years, consider the total cost of the loan, including what you will pay in finance charges and APR. For instance, if you take out a 5-year car loan for a $30,000 car, your average APR will be approximately 11.3%. At this rate, the interest paid over time on this auto loan will be $9,163.30.
4. Failing to read the fine print
When taking out a car loan, it's essential to go through all the fine print before signing any paperwork. Pay attention to the price of the car, length of the loan, and interest rate. Remember, it's difficult to argue about mistakes when you have already signed the papers, so ensure there are no blank spaces or errors on the documents.
In addition, don't leave a dealership until you are confident that the financing deal has been approved. Not doing so creates room for financial issues or financing scams, where you might be called back to the dealership several days or weeks later to sign new documents. The new deal often comes with a higher price, much longer term, and a higher interest rate.
5. Not shopping for multiple lenders
Don't just visit one car dealer when you are buying a car or when it comes to financing your vehicle. The good news is that shopping at multiple lenders is easier than at numerous car dealerships. You can visit local banks' websites, prominent national banks, online banks, financing companies, and credit unions from the comfort of your home.
Various lenders will offer different interest rates and loan terms. Every lender will likely have unique down payment standards, credit score requirements, loan-to-value ratios, and income limits. However, car loan interest can change regularly based on demand and promotions. While you can always take the dealer's financing if the interest rate is lower, remember that your approved loan will serve as a bargaining chip to acquire its best rate.
6. Taking out a loan that is too long
It might be tempting to acquire reduced monthly payments on your vehicle, but the longer your auto loan term, the more you will pay in full interest. Longer terms typically come with a higher interest rate that you will have to pay for an extended period. In addition, the longer the term, the more likely your car's value reduces to the point where you turn upside down on your auto loan.
Generally, five years is considered the maximum term length you should consider. Try to choose a shorter-term duration with greater monthly payments, so long as it can fit into your budget. You can use an online EMI calculator to understand better what would suit you.
7. Failing to make a down payment
You will likely get a good financing deal if you make a considerable down payment on a brand-new or used car. One of the things that loan providers consider is the loan-to-value ratio (LTV), which compares the loan balance to the car's resale value. The lower the LTV, the less risky the loan is to the lenders, which translates to better loan rates and terms.
Making a big down payment helps you get a shorter loan term, which generally comes with a lower interest rate and reduced monthly payments. There are also lower chances you will capsize on your loan since the car's value has a better chance of remaining above the amount you owe.
Summing it up
Approaching your car loan finance with a clear mind and realistic expectations is the best way to avoid the most common car loan mistakes. Ensure you know everything you can about your situation, including your budget, credit score, borrowing power, and the car you wish to purchase.
Remember to consider the total cost of the loan. Although it may be tempting to make each monthly payment as low as possible, it is not worth extending your loan term to absurd lengths. A low-interest rate is advantageous, but there are additional aspects to consider. Consult a finance broker about your situation.