Whether it is your first car purchase or your fifth, it may be wise to know which is the best way to finance the purchase. So that you can spend all your time researching different car models before the purchase, we have compiled a simple overview of how car loans work. Which is really best? Car loan with or without the car as collateral?
Two ways to finance the car
When the term car loan is used, it is usually a loan where the car serves as underlying collateral, like a mortgage where the property is mortgaged for the loan. From the name of judging, it is easy to believe that car loans are the only and best way to pay for the car, but in fact it is also possible to use loans where the car is not used as collateral. This type of loan is called a private loan and, as with many other things, there are pros and cons of both options.
Car loan - Loan with the car as collateral
The car loan can be said to be a relative of the private loan - they derive from the same principles but have some distinct differences. The biggest difference we have already mentioned and that is that the car financed with the loan is also pledged for it. This means, in short, that the bank or credit company unlocks its money at something of the same value as the loan amount. In this way, they can guarantee their money back through the sale of the vehicle if the payments were not handled by the borrower.
With a car loan, you can usually only borrow up to 80% of the cost of the car as a vehicle drops rapidly in value and then the bank's security decreases. For this reason, there is also usually a maximum limit on the repayment period because the lender wants to make sure that he can get the money back. Normally, the maturity is therefore somewhere between 5 - 8 years. It is also common for the car to cost at least USD 70,000 and if the car is used it must not be older than 10-12 years.
Something else that may be good to know about car loans is that most lenders require the car to be purchased from an authorized car dealer, which you must also be able to certify. It is possible to buy a used car privately but then you must instead be able to certify the car's condition. If the person you are buying the car from already has a loan on the car, you can apply to take over the loan at the time of purchase.
Two of the main benefits of a car loan:
- You can get a relatively low interest rate because the bank can take possession of the car if payment should not be made.
- You can apply for a car loan directly from an authorized dealer and quickly get an answer on whether it was granted or not. The lender then pays the money directly to the dealer and you do not need to act as an intermediary.
While this in itself is a good reason to take out a car loan, there are also some drawbacks to highlight:
- Your purchase is limited by how much money you have saved because you have to finance 20% of the car yourself.
- You cannot exchange or sell the car without the bank's knowledge and approval.
- Should you sell the car for a smaller amount than what remains to be paid on the loan, you must pay the outstanding debt yourself.
- You must have full insurance on the car as the lender is concerned about the value being maintained. (On the other hand, you may still want to fully insure the car since a value reduction is not in your best interest either).
Private loans - Loans without the car as collateral
Unlike the classic car loan, a private loan or unsecured loan has nothing to do with the car itself. This loan can be used for exactly what you want and what the purpose is need not be clarified for the bank. Although there is no collateral, a private loan can amount to as much as USD 600,000 and the repayment period is usually between 1 and 12 years.
With a private loan, you get money in hand that you can then use to pay off your car in its entirety - in other words, no cash contribution is needed. You also have a completely different flexibility and freedom with a unsecured loan because you do not need to mix the bank if you want to resell it, but you are free to use the car exactly how you want.
In this case, you must apply for the loan on your own and cannot contact the car dealer directly. So you first apply for the loan from a lender and once you have received the money you can use it to buy from a private person or car dealer, whatever you prefer. There is no requirement that the car must cost a certain amount or be in a certain condition.
However, a warning should be raised here. The loan still needs to be repaid in full and in order for you to be able to do so in the event of a sale of the car in the future, it can be to your advantage to certify that the car is in good condition.
Two of the main benefits of a unsecured loan:
- You decide for yourself - everything from who you buy the car to to if you have full insurance and who you sell it to.
- You can borrow the entire purchase price if you wish and are therefore not limited by your own savings. What, instead, determines how much you can borrow is your ability to repay.
Of course, there are also some disadvantages to note with the private loan:
- Generally, higher interest rates because it poses a greater risk for the bank to lend to you without any collateral.
- Your credit rating may limit your ability to be granted larger amounts.
- Rapid depreciation can make the part you have left to pay for the loan great when you sell your car. It is therefore important to repay the loan as soon as you can - a longer maturity may seem advantageous as it results in lower monthly costs but can ultimately lead to a high total cost of the loan and that the debt becomes higher than the car's value.