Part 1: What is a Car Loan, How Auto Loans Work, What is the Monthly Payment
Part 2: Things to be Considered when Financing a Car, Should You Get a Car Loan
Introduction to a Car Loan for Kids and Teens
This video explains the concept of a car loan in a simple, concise way for kids and beginners. It could be used by kids & teens to learn about car financing, or used as a money & personal finance resource by parents and teachers as part of a Financial Literacy course or K-12 curriculum.
Suitable for students from grade levels:
- Elementary School
- Middle School
- High School
The topics covered are:
- What is a Car Loan
- How Auto Loans Work
- What is the Monthly Payment
- What Should You Keep in Mind When Financing a Car
- Should You Get a Car Loan
What is a car loan?
A car loan – also called an auto loan – is a way to finance your car.
It allows you to borrow money from a lender in order to purchase a new or used car.
You pay back the loan with interest through monthly payments over a set period of time.
You can get a car loan directly from the car dealership, or through a bank, credit union, or an online lender.
How do auto loans work?
When you want to take out a car loan, it’s best to comparison shop lenders to find the ones that offer you the best loan terms.
Once you have chosen your lender, you submit an application and provide the necessary documentation for the lender to determine your creditworthiness.
After the lender approves the loan, you make a down payment, usually around 20% of the vehicle’s purchase price. The rest is given to you as a loan.
Over a certain amount of time – called the loan’s term – you pay off the loan through monthly installments. This includes principal (the amount you borrowed) and interest.
The average term of a car loan in the US is 72 months (6 years). However, the term can be as short as 12 months or as long as 96 months.
The majority of car loans are secured, meaning that if you are unable to pay it off, the lender can sell your car to recover the remaining loan amount.
What is the monthly payment for car loans?
Your monthly payment depends on the APR or the effective interest rate you qualify for. The average interest rate for new car loans in the US is between 5% and 8% – and auto loan rates are over 10% for used car loans.
However, the interest rate varies greatly based on your credit score (the higher the better), as well as factors such as the loan amount, term of the loan, etc.
If you make a sizable down payment or trade-in your old car, your loan amount would be reduced, bringing down your monthly payment.
Also, longer term loans will bring down your monthly payment – although you’ll end up paying a lot more in interest over time!
It’s important to note that car companies sometimes run promotions where you pay no interest for a certain amount of time – sometimes as high as 5 years!
What should I consider when financing a car?
The most important thing to keep in mind is the interest on the loan.
To minimize the amount of interest you pay, try to make a large down payment and go for a short loan duration. Or, you can try to wait until there is a special event where you pay zero interest for some time.
While you get to use and enjoy the vehicle, you don’t own it until the loan is fully paid off. The lender holds the title of your vehicle for the entire loan duration.
Also, the longer the term of the loan, the lower your monthly payments. However, you’ll end up paying a lot more in interest – so it’s best to pay off the loan at the earliest!
Refinancing your car loan can be a great option, especially if the interest rates go down after you got your loan or your credit score improves significantly.
Remember, even a 0.1% decrease in the interest rate can save you hundreds of dollars over the life of the loan.
Should I take out a car loan?
If you can afford to save up and pay for a car in full, that’s ideal since the interest on a car loan is significant. However, that’s not possible for many people – in which case an auto loan can be a good choice.
Make sure to comparison shop to get a low interest rate, as it could save you thousands of dollars over time.
Sometimes dealers can offer incentives like 0% interest or special terms from the manufacturers that could be better than a private lender. At other times, banks, credit unions or online lenders can offer much better rates.
Remember, there is no one-size-fits-all approach. Everyone’s financial situation is different and you need to make the decision that’s right for you.
For instance, a longer loan duration may help free up some cash towards repayment of other higher interest debt. Or you could go for a shorter duration and make higher monthly payments to save a lot on interest.
And make sure to only purchase a car you can actually afford!