How auto loans work
Auto loans work: As you can understand from the term itself, an auto or car loan refers to loans that people take to finance their purchase of a new four-wheeler. It is an installment loan and is a legally enforceable contract that states that the lender will lend you the money to purchase a car, and that you will repay the loan in full, plus interest, by a certain deadline.
Such loans make it easier for many people who wish to purchase a car by breaking down the expense into installments paid over some time. You can easily calculate your EMI using the HDFC Car loan calculator.
Read on to learn about how car loans work and things to consider beforehand
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How do Auto or Car loans Work?
As we know, by dividing the cost of a vehicle into monthly payments over time, a car loan can help make your big purchase somewhat more manageable. Depending on the lender, they often have durations of 24 to 84 months for repayment. The car you intend to buy and your financial status will determine how much you can borrow.
Your monthly auto loan payments will be counted towards both the principal loan balance and the lender’s interest fees. The interest rate you are eligible for will determine your overall interest costs. In general, your rate will be better the higher your credit score. Many lenders also give customers who choose shorter repayment durations reduced interest rates.
It should be noted that the lender will maintain a lien on your automobile while you are paying off your auto loan, giving them the right to seize the car if you default on your payments. The majority of lenders will also hold the title to your car during this repayment period. The lender will no longer maintain a lien on the property if you return the loan in full, at which point you will receive the title.
Auto Loan Terminology To Keep In Mind
Before moving further on with the workings of auto loans let us look at some important terms that you should know.
- Principal – This is the sum of money that you borrow with the intent to repay the lender at a pre-assigned time. Notably, this excludes any applicable interest, charges, fines, or other expenses.
- Interest Rate – In essence, the interest on a loan is the fee a lender charges in exchange for making loans. Your interest rate, which is written in terms of percentage, shows how much interest that you can expect to pay on the loan. The lesser your interest rate the smaller amount you are charged on your loan. Your credit score must be between good to excellent if you are to become eligible for a good interest rate. Many lenders also give customers who choose shorter repayment terms reduced interest rates.
- Monthly Payment – This refers to the amount that you must expend each month toward an auto loan. The principal of your car loan will receive a portion of this monthly payment, and the loan’s interest will receive the remainder. The division of your monthly payments between principal and interest depends on how your interest is calculated. Your loan might charge Simple interest which is based on the loan balance as it stands on the due date for your payment. Or your interest might be pre-calculated in which case it will depend on the amount you borrow when you apply for the loan and is calculated at that time. In any case, you can easily calculate this using the HDFC Car loan calculator.
- Loan Term – The duration you are given to repay your debt is known as the loan or repayment term. Depending on the lender, auto loan terms often range from 24 to 84 months. The shortest term you can afford is typically the best choice if you want to keep your interest expenses as low as possible.
- Annual Percentage Rate – The interest and any fees you are required to pay on the loan will both be included in the annual percentage rate (APR). The cost of your loan will increase as the APR rises. Make sure to check and contrast APRs rather than just interest rates as you compare your alternatives from various auto loan providers to get a better idea of how they compare financially.
- The Down Payment – You may choose to pay the down payment on a car in cash or through the value of your trade-in. Moreover, you can even opt for a mix of the two. The remaining amount can then be financed via a car loan. A down payment of at least 10% of the car’s purchase price is frequently required by auto loan lenders.
- Co-signer – A co-signer is a person with good credit who is willing to share responsibility for your auto loans, such as a parent, a sibling, or a reliable friend. Having a co-signer may help you qualify for a loan more easily and may also result in a cheaper interest rate than you would otherwise receive. Just keep in mind that they will be responsible if you are unable to make your payments.
Qualifying for an Auto Loan
There are certain specific criteria that you need to clear before you can get an auto loan. The most essential requirements for a car loan are –
- Credit Score – The first determinant of your eligibility is your credit score which needs to be between good and excellent if you want to get a car loan without paying an exorbitant rate of interest.
- Income Proof – You must demonstrate your ability to repay to qualify for a loan. You will typically be required to provide sufficient details to the loan provider about your financial condition, starting with your income. For this, you need to be ready to present pay stubs or a copy of your tax return so that your income can be verified.
- Debt-to-Income Ratio – Your debt-to-income (DTI) ratio measures how much of your income is going toward your monthly debt payments. Your DTI ratio should be no more than 50% to be accepted for an auto loan, while some lenders have lower requirements.
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