In an ideal world, we would all buy our cars for cash and never have to think about monthly payments, debt and equity. In reality though, only a little percent of buyers have enough cash to pay for a vehicle outright, so most of us have to finance.
Financing means borrowing money for a car from a bank or a credit union and paying as you drive it. Such a vehicle is owned by a bank until you make the last payment.
The primary things you need to consider while getting a financing are the down payment, the amount of your monthly payments, interest rates and the term of the loan.
The down payment is the cash you are required to pay up front when financing a car. This sum is then credited against the total balance of the loan. That is to say, the more you put as a down payment, the less you owe to the bank. The statistics of the recent years shows a trend of making small down payments—about 12 per cent in average. However, a sensible decision is to put down as much as you can possibly afford. Making a bigger down payment brings several benefits. First, having less money loaned helps to avoid negative equity—a situation when you owe more than your vehicle is currently worth, which comes with car depreciation. Apart from that, you get smaller monthly payments and finance charges.
Interest rate is a fee you pay to a lending institution. It is calculated as a per cent of the sum you borrow and is affected by a number of factors. One of them is your credit score. The lower it is, the higher is the rate. The rate also depends on the term of the loan. Longer loans have higher interests rates, so while a monthly payment of a long-term loan is lower, the cumulative financing charges are considerably higher than that of shorter loans.
This is one of the reasons why you’d better avoid loans longer than 60 months. In addition, by the time you approach the last payment in an extra-long loan (6 years and more) the car will lose too much value due to depreciation, or you can simply get tired of that vehicle while still having to pay for it. On the other hand, too short loans increase your monthly payments.
A thing to remember is that monthly payments are accompanied by operational costs of the vehicle, such as fuel, maintenance and insurance, so keep those additional expenses in mind while considering various financing offers.
Understanding what you pay for and a pragmatic planning of your budget is a key to a good car financing.