Are you thinking about buying a new car? While visions of family road trips and that new car smell may fill your head, you’re likely going to have to think about something less enjoyable before you drive your new car off the lot: paying for it.
Most Americans living in cities where driving is essential find it necessary to obtain a car loan to finance their vehicle purchase. Unfortunately, the size of the loan can leave consumers with a hefty car payment. As of December 2021, the average new car loan amount was over $37,820. The average monthly payment for a new car was $644, and $488 per month for a used car.
Comparing Types of Car Loans
There are two main types of car loans: direct loans and dealer financing. A direct loan is a traditional loan from a bank or financial institution, while dealer financing is a loan obtained through the dealership – sometimes referred to as “buy here pay here” (BHPH). Direct loans are much more common, and dealers generally sell the loan they offer you to a bank or credit union, which then services your account.
Although this means the two options are very similar once you start repaying your loan, car dealers may be able to offer special incentives from manufacturers or other deals that banks can’t provide.
Factors That Determine Your Car Payment
Regardless of whether you choose to take out a loan from your bank or from the car dealership, your monthly payment will be determined by the same factors: your income, credit scores, and debts. Your debt-to-income ratio is an important factor that lenders use to evaluate your creditworthiness. If you have a high income and relatively low debt, you’ll be more attractive to lenders and may receive better lending terms. However, if you have a high income and equally heavy debt, you may be considered a greater risk to lenders, thus less likely to qualify for a loan with very favorable terms. If you have a poor credit score, it may be difficult to obtain a loan at all.
Age of the car. This may seem counterintuitive, but the newer the car, the better your loan terms will be. If something happens that makes you unable to repay your loan and your car gets repossessed, the bank or dealership may find it easier to resell a newer car compared to an older one – thus giving them more incentive to risk supporting this asset.
Loan term. Shorter loans generally come with more favorable terms because they indicate that you have a higher ability to repay your debts in a reasonable amount of time. However, shorter loans will generally come with higher monthly payments since you’ll be paying off the balance over a shorter period.
Loan amount and down payment size. Putting down a large down payment signals to lenders that you are serious about this investment and may lead to a more attractive interest rate. A larger loan, especially if you have a high debt-to-income ratio, is likely to come with a higher interest rate, while a smaller loan is likely to come with more favorable terms.
Annual percentage rate (APR). The annual percentage rate (APR) is the rate you will pay each year on your loan, plus any fees. Older car loans generally come with higher interest rates because they have a lower resale value. A variety of factors go into determining the interest rate you will be offered, including your credit history, market conditions, and special offers. While it’s uncommon to have an interest rate that changes over the life of your car loan, you should pay attention to the fine print because a variable rate could end up costing you!
Before
Buying
In addition to the monthly installment, if you are planning to buy a new car, you should plan for insurance costs, fuel prices, taxes, registration fees, maintenance and repairs, as well as the resale value of the car if you decide to sell it. Remember that insurance and registration prices can vary significantly from state to state. Although it may seem like a nuisance, doing these calculations and research will give you a more realistic picture of the type of car you can afford based on the advertised price and will enable you to stand firmer in negotiations at the dealership. If you can, consider driving your old car for a longer time, sharing a car with others, or using public transportation while saving money to buy a car.
Conclusion
The decision to buy a car is one that should not be taken lightly, nor is the decision to get a loan for your car. Consider saving for a down payment to save money in the long run. Shop around for the best loan terms. Compare the dealership’s offer with your bank’s offer, or consider borrowing from a family member. Review your state’s laws to determine your rights as a borrower. With some research, you’ll be fine owning a car that can last for years to come – while keeping your financial future in mind.
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Sources:
- The Federal Reserve Bank of St. Louis. “Average Amount Financed for New Car Loans at Finance Companies.”
- Credit Karma. “What Is the Average Car payment?”
- Consumer Financial Protection Bureau. “What Is the Difference Between Dealer-Arranged and Bank Financing?”
- National Automobile Dealers Association (NADA). “Understanding Vehicle Financing,” Download.
Source: https://www.thebalancemoney.com/average-monthly-car-payment-4137650
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