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Car Loans: Understand How They Work

by pps-DUEditor

When you’re buying a car, you spend a lot of time checking out the car’s details. But do you do the same thing to understand car loans? You should. When you finance a vehicle, you receive the money as a lump sum and then pay it back with interest over time. Your monthly payment depends on the borrowed amount, the interest rate, and the time over which you repay.

The loan amount can be a lot less than the value of the car. This depends on the trade-in value of your current vehicle or your down payment amount. The APR is the effective interest rate on your loan, and the lower this is, the better. The loan term, usually between 36 and 72 months, is the repayment period.

The above three factors combine to decide your monthly payment amount. A lower monthly payment sounds good at first, but it depends on the bigger picture. If the lower payment means a longer payment period, then you’re paying more for your car over the life of your loan. If you borrow less money by making a larger down payment, then you’re definitely going to pay lower EMIs every month. Additionally, you may notice that different financial institutions offer different APR rates. Even if the difference is small, taking the lower APR will save you money. But in case you opt for a longer loan term, your monthly payment will seem very low, but you will definitely end up paying a lot more as interest over the years. Use an online loan calculator and play around to understand how these factors will affect your payments.

Longer loan terms also carry other risks. While you may be happy with the lower monthly payments, you’re wasting money paying too much interest. Additionally, if you’re paying off the loan for five to seven years, you may be stuck with a car that you want to get rid of. Worse, in case the vehicle isn’t worth as much as you owe, you’ll be upside down on the loan. You won’t even be able to sell the car and pay off the loan. That’s why you need to consider every factor and its long term effect.

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