how do loans work for a car

Planning to buy a car? then you need to know how do loans work for a car

Driving your car is like a dream come true. 

Ever since we are kids we play with toy cars and dream of having one when we grow up. We talk about colors, we talk about looks and how big is it going to be, what model we want and the number of cars we eventually want in our driveway.  But as we grow old we realize the budgeting and financial responsibilities of owning a car. 

And today car loans can help us with finances. Taking a car loan is an important decision. But applying for a car loan can be a complicated process and if you are new to this process it can be confusing at first. 

This article will simplify the journey from understanding how does car loan work to applying for one to eventually owning your car. 

Let us begin the process of understanding how do loans work for a car & cover the basics.

What is a car loan? 

The car loan is a legally binding agreement between you and the lender that says they will give you the required funds you need to buy a car, which you will return over a period of time along with the pre-decided annual rate of interest. 

The amount you borrow, how much time you borrow it for, your annual income, and the rate of interest decide your monthly installments. 

How much should you spend on your first car? 

There is a general rule of thumb when you decide to buy a car: 

Do not spend more than half of your annual income on your new car. 

how do loans work for a car?

A car loan will help you ease the financial burden of purchasing a car, by paying the company on your behalf. And you can return the amount in small monthly installments over a pre-defined period of time. For this, the bank charges a fee in the form of interest from you. 

The loan amount depends on your needs and your capacity to return the amount. The time period generally varies from 4-8 years. 

While giving loans and charging interest on that loan is one of the main purposes of banks, banks often do a strong background check on the individuals applying for loans. To make sure they will be able to return the money. 

The higher your credit score better the deal bank will offer you.

Note here that, till the entire loan amount is paid, the bank will be the lienholder on your car, which means that they can take away the car if there is a long delay in payment of the installments or if you fail to make the payments altogether. 

Only when the entire loan amount is returned, the bank or lender will release the title of the lienholder and the car will belong to you by all means. 

Key terms that one must know before applying for a car loan. 

Applying for a loan can be a challenging and technical process, therefore it’s necessary to familiarize yourself with the technical terms. So you can ask your lender the right questions and make conscious choices. 

1) Rate of Interest 

ROI on a loan is what the bank/lenders charges in return for providing the loan. The higher the loan amount, the higher the rate of interest. 

Although you can get a better deal if you have maintained an excellent crest score.

2) Annual Percentage Rate 

APR is the amount you pay to borrow a said amount from the bank/lender, it is the sum ROI & any additional annual fee. It is the total amount you pay in return for borrowing money. The higher the APR, the more amount you will have to pay to return your loan amount. 

3) Down Payment 

It is an initial upfront payment you make for the car and the rest of the amount is taken as a loan from the bank. Minimum its 10% of the car price and can go as high as you want. A higher downpayment means you will have to take a smaller loan from the bank, thus smaller interest. 

4) Loan Term 

It is described as the duration in which you have to return the amount to the bank. It can be anywhere from 4-8 years or even longer in some cases. 

An important thing to consider here is that a longer duration might reduce your monthly installments but increase your annual APR. 

5) Principal 

This is the amount that you are borrowing from the bank. 

The downpayment, Rate of interest, and fee are calculated based on this amount.

6) Monthly Payment 

This is the amount you pay to the bank each month. A part of your payment goes towards the principal amount and the rest is towards interests and other fees. 

7) Co-signer 

If you are struggling to get your loan approved, a co-signer or guarantee can help you in that scenario. Along with the ease of getting approved having a co-signer can get you a lower rate of interest. 

The important thing to understand here will be that if in any case, you are unable to make the payments, the co-signer will be on the hook. 

8) Total Payment 

It is referred to as the sum of the principal amount, interest rate, and any other penalties fined by the bank. It is the entire amount that you will have to repay to the lender. 

How to know if you are eligible for a car loan? 

You need to meet certain eligibility criteria before applying for a loan. 

1 ) Credit Score 

The lender needs to know your credit score. Which represents your financial credit history. Your credit history will tell the lender if you have been punctual in the past with your installments. When you are responsible with your finances and make installments in time, your credit score increases. A higher score increases your credibility. 

2) Regular Income 

You need to show proof of regular income while applying for a loan. For ex- Bank Statements, Income Tax Returns, etc. And if you are a freelancer or self-employed you will need a few other documents, as per your bank’s requirements. 

Your annual income will decide how much loan you can apply for. 

3) Vehicle Eligibility 

You must check the vehicle list your bank approves for loans. It’s often different for different banks.

4) Residential Proof 

You need to provide documents with details like your permanent address, social security number, contact number, and mailing address. 

5) Downpayment 

You need to have seed money, even if you are applyin for a loan. A bank will only give you 80%-90% of the amount that you need while you pay the rest upfront as the downpayment for your car. 

6) Ongoing Loan / Credit 

You need to share your credit history & if there is an ongoing loan on you with your lender. 

Where should I get my car loan from? 

Applying for a loan is a complicated process and a long commitment, which is why it’s always a good idea to explore the market and read the policies of various banks, and lenders to understand which suits you best. You must clear all your doubts with the respective lender before signing the deal. 

Who issues the car loan & how does a car loan works? 

You must do as much research about your car loan as you have done on your car. Taking a loan is a huge responsibility, and you must be aware of all the aspects before you enter into a relationship with your lender. 

Generally, there are two ways to get the money 

1 ) Dealership Financing 2) Direct Financing 

Dealership Financing– As the name suggests, the loan is offered by the car company you are purchasing car from. They become a bridge between you and the lender, they complete the needful paperwork while you have to do very little. There can be hidden costs involved for the services they provide, which is why you need to go through each document carefully. 

Direct Financing– Here the lenders directly work with borrowers. You can directly approach a bank, credit union, or other financial institutions for your car loan and compare their policies, their terms & conditions. And finally, go with the one which meets your financial needs.

If you already have a savings account in a specific bank, that particular bank might offer you a better deal on your loan since you have been their old customer. 

Can someone take over your car loan in case of emergencies? 

Unless you have a guarantor who is ready to take the responsibility of paying the installments on your behalf, till the time you are out of your financial crisis, it can become tough situation. Rarely a bank lets you add a new guarantor once the loan has begun. 

If you are falling behind on repayments, the bank has the right to take possession of your car. 

If you have been regular with your installments there is a possibility a bank might offer you some leniency for a certain period of time. 

This is why it’s always helpful and advised to maintain a healthy credit score. Not only it can help you secure a better loan deal, but it might also help you in case some complications regarding repayment come up. 

It is important to note here that while the bank may offer some leniency it might add some more interest on future payments. 

Are you ready to apply for a car loan now? 

You must take an ample amount of time and research well on all your available options. Considering the financial aspects, buying a car should not become a burden, rather it should bring comfort and ease to your lifestyle. 

Explore the loan market and find a suitable lender as per your needs. Ask questions, you need to have absolute clarity before signing any papers and finding yourself in a challenging situation. 

Buying a car is a huge responsibility and a wonderful experience, make sure you enjoy the ride by being aware of all the aspects of financing and maintenance. 

Happy Driving!

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