5 Car Loan Pitfalls to Avoid

• Posted on Autos.com Editor
• in Auto Loans
• on October 7, 2013

If you’re thinking of buying a car, but don’t have the cash to pay for it, you may need to apply for a car loan. Car loans are fairly common, and even if your credit is less than perfect, there are banks out there willing to finance you. But beware of these five car loan pitfalls to avoid, particularly if you’ve never applied for an auto loan.

1. Bundled Deals

Car dealers want to make money. They may give you a great deal on your vehicle, and then hit you with high car loan rates to make up the profit difference. Know the value of the car and the rate you are eligible for before you walk in the door. Try applying for financing before going to the dealership, which keeps your auto loan terms separate from purchase price.

2. Buying More than You Can Afford

Car loans have a direct impact on your credit score. The higher the loan, the more it negatively affects your credit. And if you struggle to make the payments, you run the risk of missing one or more auto loan payments. At a minimum, your credit will take a hit for missed payments.

3. Not Understanding the Impact of Compound Interest

When you finance a vehicle, you pay car loan interest over time. That means that after it’s all said and done, you’ll pay more to own the car than the agreed-upon sale price. For example, if you spend $15,000 on your vehicle and finance it at 7% interest over five years, you’ll end up paying over $2,800 in interest.

4. Missing a Payment

Car loans are different from credit cards in that they are secured, whereas credit cards are unsecured. That means that the car acts as collateral to secure the car loan. If you default on your loan, your car will be repossessed. After you’ve made payments for a couple years, the bank may let you slide on a missed month or two. But during the first year, you could lose your car after a single missed payment.

5. Loan Balances that Exceed the Balance of the Vehicle

If you have a long payback period on your car loan, then you won’t be paying down the principal as quickly. This becomes significant when you total your car or try to sell it, and you find that you still owe more money than the vehicle is worth. You can purchase gap insurance to cover the difference in the event that you find yourself in this situation, but the best alternative is financing for five years or less.

It is possible for you to finance a car safely and reasonably. Just be sure you know what you’re getting into. Be prepared to avoid deceptive bundle loans. Don’t buy more than you can afford. Understand compound interest. Never miss a payment. Finally, agree on terms that pay off your car in five years or less.