The Benefits of Understanding Car Loans

If you can pay for a car in cash, do so; if you can’t, keep reading. Unless you live within walking distance of everything you need, you need a set of wheels. You should never walk onto a new or used car lot ignorant, however. Financing a vehicle is a long-term commitment that could have serious ramifications if you don’t hold up your end of the bargain. Understand car loans first.

Loan Amount

Bank of America explains that there are three important factors that go into what will become your monthly car loan payment. The first of the three is the loan amount or the vehicle’s total cost. In some cases, the loan amount will be, as Bank of America says, “significantly less than the value of the car,” but why? First, take into account the down payment. Unless you have stellar credit, you’ll probably be required to put a down payment on your new or used car. This amount is deducted from the total contract, so put down as much as you can.

The financer may also reduce your total loan amount by the value of any car you trade in for the new car, so keep your current vehicle in the best shape possible. The more you can deduct from the overall contract, the lower your monthly payments, and final vehicle price. Sure, the sticker on the window may give an MSRP of $25,000, but the longer it takes you to pay off the vehicle, the higher over that $25,000 the price becomes. Also, know that the dealer didn’t pay $25,000 for the car, so ask what the invoice price is instead of settling for the MSRP.

Annual Percentage

Head back in your mind to basic math class for this part of how car loans work. The less you finance, the less you pay in interest fees. Because you are taking out a loan on your vehicle purchase, you will pay interest, period, and this is what adds to that loan amount. The annual percentage rate, or APR as it’s commonly called, is added to our monthly payments, so some of that money goes directly to the financer, not to the principal (your vehicle amount). The lower the interest rate, the less you pay for your car or truck in the end, but that isn’t all.

The car you want has an MSRP of $25,000. You buy it for that and give the dealer a $2,000 down payment. Your trade-in is paid off but super old. The dealer gives you $1,000 for it. You’ve just reduced the car’s price to $22,000. Your APR is going to be 5 percent. You finance the car for five years. Your monthly payment will be $416, but the total amount you pay for the car is $24,690. Now, negotiate the dealer down to an invoice price, say $18,000. In this case, your monthly payment is $340 and you will pay $20,400 to pay it off. The less you have to finance, the less you will pay in interest, which means you will get the car at a lower price once it’s finally yours.

Loan Term

Finally, as you could see in the example above, the longer you take to pay off the loan, the more you’ll pay in APR. Automobile financing is complex, and many people just look at the monthly payment to make their decisions. Yes, the monthly payment will be cheaper if you extend your contract out five years as opposed to three, but do some more math. In the example above, the contract had a five-year term at a 5 percent APR. You would pay $2,690 more for a car with a $25,000 total price and $2,400 more for a car priced at $18,000. So, what would the numbers be on a three-year loan?

While the car payments for the $25,000 total price would $750 per month, you would only $2,000 extra over the three-term. For the $18,000 car, the payments would be $540 and the three-year interest investment would be $1,440. You’ll save more money if you can finance the vehicle under a shorter term contract, and the reason why is simple: You aren’t paying as much interest over time. In this example, you saved yourself two years worth of interest alone.

When you take all of this into account, it’s easy to see why you must head to the dealer an expert on auto loans. Now, you are! Take what you’ve learned and head to the dealer with the confidence you need to get the best deal.

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