How Does A Car Loan Work?

The importance of owning your own car cannot be over emphasized. However, unfortunately not everyone can pay upfront for their cars or ever own one in the first place. And that is where car loans come in to help persons who cannot pay upfront for their cars to also purchase their desired cars and pay back over a period of time. But how does a car loan work in the first place?

What have you heard about how car loans works? To begin with, Car loans and Car Finance are two terms that are often times used interchangeably to mean the same when in actual fact they have different meanings and work differently.

However in this article, we will be focused on looking at how Car loans work. A different article will be dedicated to explain how Car Finance also works.

READ ALSO: Is It Better To Get A Car Loan Through Your Bank Or The Dealership?

What Is A Car Loan? 

A car loan is simply a loan you obtain from a lender solely to purchase a car and pay back in installments over a period of time. It can be gotten from a financial institution such as your bank, credit union or any other bank of your choice.

A car loan can either be Secured or Unsecured with both having their own merits and downsides. This then brings us to our topic “how does a car loan work” to give you a better understanding of the subject matter.

How A Car Loan Works 

As mentioned earlier, a car loan is that loan which you obtain from either a bank or credit union to purchase your car. It is a very common way of buying cars in the U.S and other parts of the world.

When you are able to get a car loan before going to the dealership, you are in a better position to negotiate for a good deal. This is because you will be going there as a cash buyer hence the avoidance of any extra charges and higher loan rates.

Additionally, a car loan can either be Secured or Unsecured and you must know the difference between the two in order to go for the one you’re comfortable with.

Secured Car Loan

As is the case in all other types of secured loans, a secured car loan also requires a collateral. In this case, the car you’re buying will be used as collateral so that in case you fail to make payments in future, the bank or credit union can repossess your car.

Due to that, secured car loans come with lower interest rates because they are considered less risky by lenders as compared to Unsecured car loan. This then means that your loan will cost less as compared to an Unsecured Car loan.

Unsecured Car Loans

Unsecured Car loans on the other hand is a car loan that does not require any form of collateral. Meaning that your lender does not have any asset of yours to rely on in case you fail to make payments hence making it very risky to them ie. your bank or credit union.

So in order to guard against a possible loss, interest rates are pegged higher than secured car loans. This then results in higher monthly payments as well.

The most common type of car loans is a secured car loan because it’s less risky for lenders.

Merits of a Car Loan 

Here are a few merits in going for a car loan

  • Ability to compare rates of at least two or three lenders before deciding on which lender to go for
  • Have longer loan terms
  • Collateralizing your loan helps you to get lower rates
  • Opportunity to choose your own dealer
  • No down payment required
  • Ability to get pre-approval

Downsides of a Car Loan 

Despite its positives, car loan has a number of downsides which includes:

  • Strict credit score requirement
  • longer processes

READ ALSO: How Does A Car Loan Cosigner Work

Is a Car Loan worth it? 

Yes and no! It all depends on your situation and what deal you sign up for. If you desperately need a car but cannot pay upfront from your savings, then the most ideal option that comes to mind will be to go for a car loan.

But the kind of deal you get and your situation will determine if it is worth it or not. For example if your monthly payments is such that you’re unable to sustain yourself with the balance of your income, then it is not worth it.

Paying more than the actual value of the car isn’t a good deal as well. So for a car loan to be worth it, your monthly payments for example shouldn’t put too much burden on your finances.

Additionally, choosing a longer loan term which will bring your monthly payments down may look like a good idea. However, doing that means your loan will cost more due to interest. So the best thing to do is to go for a term not exceeding 3 to 5 years.

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