Things to consider when applying for a car loan
Picture this: your beloved car is now beyond repair and it’s time to start thinking of purchasing a new one. But how should you finance it? There are a variety of options available when it comes to buying a new car, whether you finance it yourself from your savings, get a financing scheme through the dealership or take out a car loan, and it can sometimes become overwhelming, to say the least. But what do you need to consider before taking out a car loan?
What if I want to pay my car loan off early?
What if my car loan repayments are too high?
When you should not take out a car loan?
Some alternatives to car loans
What is a car loan?
A car loan is a type of personal loan that you can use to pay for a car. Unlike traditional personal loans which can be spent on anything, a car loan is tailored for use only to purchase a vehicle. Repayments can be made over a number of years, sometimes stretching over up to seven years, however, your credit score could affect the loan amount you can apply for and the interest rates you could be offered. Take a look at our article on how the top three credit bureaux measure credit score, and if your score is not as you had expected, read our 10 steps to improve your credit score.
Who can get a car loan?
To be eligible for a loan you need to be over 18 years of age, and each loan provider will have its own set of criteria that you have to meet in order to qualify for one of their financial products. Then, to make an application, you should need to provide your personal details and provide your typical expenditures, your employment status and your salary to ensure that you will be able to pay the loan back. Typically, before lending to you a lender should perform a hard search on your credit file, however, if you are rejected and a lot of these hard searches appear on your file in a short space of time, your credit score can be negatively impacted. This is because numerous applications for credit can indicate that you are desperate for a loan and therefore are in financial difficulty – not the impression you want to give to a prospective lender.
Before applying for a loan, it is a good idea to check out your own credit report, to look into how likely it would be that you could apply for credit. Looking at your own credit report produces a soft search, which lenders are not able to see and will not negatively impact your credit rating.
NOTE: Some comparison websites and broker services carry out a soft check before giving you loan results, it is important to check whether a lender or a comparison website will carry out a hard, or a soft check on your credit file.
What if I want to pay my car loan off early?
Paying off loans early makes sense if you want to save on paying some interest, especially while the interest rates on savings accounts are so low!
However, it’s often the case that finance companies charge early repayment fees, or resettlement fees, which might amount to a sum equivalent to a month or two of interest. This does vary between lenders, however, so again, it’s definitely worth doing your homework and reading the small print before you choose your loan.
To pay off your car loan early, you have a few options. You could either pay it all off in one go with one final payment, or you could increase the monthly instalments by an affordable amount so that the loan is paid off faster than originally planned. If your credit score has improved since you first got your car loan, it might be an option to refinance the car by taking out a new loan at a better rate.
What if my car loan repayments are too high?
Fortunately, most car loans come with fixed rates of interest, which means the payments will remain stable during the term of the loan. However, you may find that your car loan repayments are too high if you suffer a loss in income, such as redundancy or a temporary loss of earnings through sickness, for example. It could be that other expenses in your life, such as your mortgage or rent payments, go up, squeezing the amount you have available for your car loan. Or, you may suddenly have higher costs, for example, if a new baby comes along!
If this happens, you may find that your car loan repayments become unaffordable and you are struggling to make the payments. In this case – don’t panic, all is not lost.
The first thing to do is talk to your finance provider, remembering that they do not want to see you in difficulty or distress. Talk to them as early as possible before you start to miss payments, to see if they can reduce the payments by lengthening the loan term for example. Not only will they be more able to help if you call them as soon as possible, but your credit score should be less affected if you seek help before you get into arrears or debt.
Your own bank may also be able to offer advice and assistance, and there are a number of advisory organisations who can help, for example, Citizens Advice, or the Money Advice Service.
Ultimately, if your car is a very expensive one, you may need to sell it and perhaps buy something cheaper but do remember that the vehicle may have depreciated in value, so shop around for a resale price before you sell.
When should you not take out a car loan?
Often, it makes sense to take out a car loan. You have a steady job, you know exactly how much you have coming in and going out, and you have no other big purchases planned for the next few months – but you don’t quite have enough savings for a car that you so badly need to get to and from work, for example.
Sometimes, however, it isn’t a good idea to take out a car loan. If your employment is unstable or in danger, or you’re planning some big purchases that will impact your monthly disposable income – a wedding, a holiday, or a new baby in the family for example. Before taking on any financial responsibility such as a car loan, you need to be certain you can afford the repayments, and if you think there’s a chance you won’t be able to, you should not take out the loan. Don’t forget, that as most cars depreciate in value, it might not be as simple as selling the car to repay the loan if things go wrong and you can no longer afford the repayments.
Some alternatives to car loans
Cash
Saving up and paying for the car outright can be a more cost-effective option as you will fully own the car right away, and you should save money as you will not have to pay interest on borrowed funds. Something to consider when paying in cash is that most cars depreciate within the first three years of ownership by 50-60%, so you may not get back what you have paid for it when it comes to reselling your car in the future.
Hire Purchase
Buying a car from a dealer with a finance deal, also known as hire purchase (HP) is a popular option, as it is usually organised through the dealer and is therefore quite easy to set up. You would typically pay a deposit of around ten percent of the cost of the car, and then make steady repayments over a one to five year period, after which the car belongs to you. It is a good option for a new car, but it can work out more expensive for a used car.
PCP
Personal contract purchase is a popular alternative to a classic car loan. Like a hire purchase deal, when you opt for this kind of finance, you make a lump sum deposit payment – though very occasionally some cars come with a very low or no deposit. Then, you spend a number of years – between one and four years would be typical, making steady monthly repayments, during which time you have full use of the car. However, unlike with a HP deal, at the end of the contract period, you then have three choices. You can either keep the car by paying one final lump sum payment, called the Guaranteed Minimum Future Value (the amount the dealer predicts the car will be worth), make no more payments and return the car and walk away, or exchange the car for a new one and start making monthly payments on a new deal once more. The advantage of this type of finance is that you have a choice of what to do at the end of the contract – you may enjoy swapping for a newer car, or you may decide you love the car and want to keep it. The downsides of this kind of deal are that there is often an agreed limit to the annual mileage you are supposed to adhere to, and you will have to pay additional fees if the car is damaged in some way, for example, if you bump or scratch it.
In Conclusion
Ultimately, you need to research all the options before you decide how to buy your next car, and If you decide that a car loan is the best option for you, make sure you take your time to compare the best car loan for you, and weigh up all the options, making sure you know you will be able to make the payments as time goes on. Then, all that’s left is to buckle up and hit the open road to take your new car for a spin!