How Does Car Loan Interest Work?

How Does Car Loan Interest Work?

Whenever you borrow, you have to pay for that privilege. And as you no doubt know, the way you pay is with interest. Car loans, like other types of credit, come with interest payments. But there are some different differences between car loan interest versus other types of interest – such as mortgages, credit cards, student loans, etc. Below I’ll explain how car loan interest works.

Car Loans Use Simple Interest, Not Compound Interest

Unlike some other types of loans, many car loans charge you simple interest, rather than compound interest. Whereas compound interest accrues on your principal and on the interest that accumulates, simple interest only accrues on your principal.

Since you only pay interest on the principal when your loan uses simple interest, you end up paying less than if it was compound interest. As an example, say you get a loan for $10,000, and you pay it off over the course of five years (60 months), which is pretty typical for an auto loan. The interest rate is 5%. Here is what your final cost (principal plus interest) would be with:

  • Compound interest (compounding monthly): $12,833.59

  • Simple interest: $11,322.74

Just by avoiding paying interest on your interest, you can save more than $1,500 over the life of this loan. However, that doesn’t necessarily mean you should get a car loan! There are more factors to consider, such as amortization.

Car Loans Use Amortization

Car loans use the principle of amortization, similar to the way a home loan is paid down. This means that at the outset of your loan, a greater amount of your payment goes toward paying the interest on your loan, and less goes toward paying down your principal.

As the loan term progresses, though, the balance shifts. More and more of your payment goes toward principal at the end of the loan.

One way you can save a little bit more on your car loan interest is by making extra principal payments at the beginning of the loan. Since the simple interest is calculated on the remaining principal periodically, you can reduce the amount of interest that you pay overall by putting extra money toward the principal.

In order to do this most effectively, it can help to make an extra principal payment each month or set up biweekly payments. Find out from your lender how best to do this. Many lenders like you to make the payment separately from your scheduled payment. The extra payment should be designated as a principal payment in order for it to have best effect. Then, the next time the interest on your principal is calculated, you will be charged less interest. You can pay off your car loan faster, and save money, by making extra principal payments.

Getting a Good Deal on Your Car Loan Interest

If you want to get a good deal on your car loan interest, it’s important for you to plan ahead. Some of the ways to ensure a lower interest rate on your auto loan include:

  • Boost your credit: Almost anyone can get a car loan from a dealer. However, if you have bad credit, you will pay in the form of a higher interest rate. If you want the best possible interest rate, you need improve your credit. Take a few months before you buy your car to actively work on improving your credit.

  • Make a down payment: A bigger down payment means that you borrow less. The less you borrow, the smaller the amount that you pay interest on. Plus, many lenders are willing to give you a lower interest rate, since the fact that you have “skin in the game” reduces the amount of risk they have to take on.

  • Look for deals if buying new: While it’s often better to buy a used car, if you are planning to buy a new car you should know that it can come with lower interest rates and/or incentives for discounted rates. As long as you are prepared for the inevitable value drop as you drive it off the lot (personally, I don’t care because we don’t sell our cars; we drive them until the give up the ghost) then you’ll be fine.

Car loan interest adds to the cost of your car so if you can, it makes sense to buy with cash and avoid the interest altogether. But, if that isn’t an option, car loan interest isn’t the worst thing in the world. At least it’s likely to be simple interest, and the rates are usually much lower than credit card interest rates. Just make sure to read the fine print and know exactly what you are getting yourself into. By understanding how car loan interest works, you can save yourself a lot of money in the long run! (And remember, ReadyForZero can help you pay off your debt as fast as possible)

Avoid These Top 5 Ways You Get Hustled When Buying a New Car

How to Avoid Getting Hustled When Buying a Car

Whether you know it or not, there’s a lot of hustling that goes on at a car lot. The industry has been given a bad rap for sure…but there is usually a kernel of truth in most stereotypes, right?

Today I am going to share with you the top 5 car lot hustles, and then show you how to decrease your exposure to them so that you can walk out of a car lot knowing that you are paying a fair price.

Hustle # 1: Unexpected Fees

When you shop at the car lot, you are given the price of the car itself. This is generally the price that you negotiate as well. However, there are lots of fees that will be tacked on after the negotiations are finished and before you get to drive your flashy, new ride home.

Standard fees that you should expect to pay are things like sales tax, registry costs and a documentation fee. Other fees that are a little dicier include things like Dealership Fees (aka “S&H” or “Dealer Prep” or even “Shipping”) and dealer-added advertising fees.

How to Decrease Your Exposure: Some states regulate the documentation fee, while others do not. If you are paying more than $100 for the dealership to process your paperwork, then you should negotiate it down. After all, isn’t processing paperwork part of the cost of doing business? Any dealership-added fees are completely negotiable (though that doesn’t mean it will be easy to do). Remember, if you cannot negotiate down some of the fees, then you can always negotiate the car price further down in order to offset the additional costs.

Hustle # 2: Dealer Add-On Markups

Something can happen to a car between when it leaves the manufacturer and when it is waiting to be sold out on the car lot: the dealer adds on extras. The reason for things like mud flaps, rear-bumper protection, floor mats, an alarm, paint protection coatings, and the like is because dealers can add on a product with a little bit of value and then tack on a steep markup on the overall price you will pay.

How to Decrease Your Exposure: Some dealer add-ons are worth it, many are not. Be sure to look closely in your contract and ask if there are any dealer add-on costs. Negotiate your way through this minefield as best as you can.

Hustle # 3: Greater than 250 miles on the Odometer

It is reasonable to expect a certain number of miles already on your new car’s odometer. This is because of test drives, moves around the lot, moves from a different lot, etc. However, be sure that your “new” car can still claim it has come right off of the manufacturer assembly line. And if it can’t, then you can use this to your advantage.

How to Decrease Your Exposure: Edmunds.com says that if there are more than 250 miles on the odometer, then you can use this as a way to negotiate a lower price.

Hustle # 4: Padding Attached

There are three potential transactions that you will be making at a car sales lot, and salesmen like to group them all together: trade-in value, new car price, and financing. When they group all three into a package deal (or two, depending upon your situation), then you can believe that they are padding each. That’s because an entire package deal often looks better and clouds the specifics of each of these transactions, thus taking away your mental alert system and negotiating power.

How to Decrease Your Exposure: You need to negotiate these three transactions separately. That way you will know whether or not you are getting a fair deal on each, regardless of the other transactions. If they insist on a package deal, then request that they give you a breakdown for each of the transactions so that you know what you are getting.

Hustle # 5: Sticker Price Padding

The sticker price on the car’s windshield is supposed to be MSRP (Manufacturer’s Suggested Retail Price). However, they may just put an inflated price on there so that when you negotiate, they will “give in” at the price that they wanted anyway.

How to Decrease Your Exposure: Do not go to a car lot blindly. Have a particular make/model in mind that you wish to buy, and then research online to find out what the actual MSRP is. This way you will know if they are misrepresenting the vehicle’s price. If you don’t happen to know what type of car you want to buy, bring along your smartphone (or a friend/family member who owns one) and look it up on the spot.

Since you are in the market for a new vehicle, I would like to leave you with one final note on car warranties. Tom Torbjornsen in his book “How to Make Your Car Last Forever,” explains that a car warranty is often misunderstood. Customers see these as an entitlement, whereas it is actually an agreement between you and the car manufacturer. You need to follow specifications outlined as recommended in your manufacturer pamphlet to fulfill your end of the responsibility, and the manufacturer will then be obligated to perform any repairs due to a defect from poor workmanship or a failed part for the time/mileage set forth in the terms of agreement. In other words, when the car lot salesman discusses “warranty” and how great it is, just remember that it will likely cover a lot less than you think it should.

How Much Does One Late Car Loan Payment Hurt Your Credit Score?

How Much Does One Late Car Loan Payment Hurt Your Credit Score?

What’s the impact of one late car loan payment? Well, it can be significant. Because payment history is the most important factor influencing your credit score, a late or missed payment on any kind of debt can change your score for the worse. This is especially true for larger payments, and for installment loans.

In many cases, your car loan qualifies as a “larger” loan — and it’s an installment loan as well. For many consumers, the only installment loans with larger balances than a car loan are mortgages and student loans. This means that one late car loan payment can hurt your credit scoremore than you might think.

The Higher Your Credit Score, the Bigger the Hit

One of the realities of your credit score is that the higher your credit score is, the bigger hit it will take if you are late on one payment. This is true of one late mortgage payment or one late credit card payment as well, when paying 30 days late can drop your score 100 points if you have a score of 780. The drop is less if you have a lower credit score.

The same is true of a late car loan payment. If you have a higher score, you have more to lose. A late payment for someone with good to excellent credit is sometimes seen as an indication that trouble is coming. You are seen as someone who is formerly very financially responsible, but who might become unreliable. On the other hand, someone with an already-poor credit score isn’t exactly acting out of character with a late car payments. It’s in line with expectations, so the hit to the credit score isn’t as large.

How Late Is Your Payment?

In some cases, if you are only a few days late with your car payment, the lender might not report the payment as well — especially if it is an isolated incident. Paying a couple days late on your car loan, unless late payments become habitual, might not have any impact, since it’s up to the lender to report payment issues to the credit bureaus.

The later your payment, the more likely you are to see an impact from your delinquency. Once you hit the 30-day late mark, lenders are inclined to report you to the credit bureaus even if they initially cut you some slack during the first 30 days. And the longer you wait, the worse your credit score is impacted. A payment that is 60 days late will bring your score down further, and a payment that is 90 days late can damage your score further.

If your single late payment is late enough (this usually happens at the 90-day mark), your lender might decide to begin the repossession process. This means that the lender might decide to take your car from you and then sell it, using the proceeds to try to recoup some of the losses associated with lending you the money to buy the car.

What To Do If You Pay Late

A late car loan payment can be serious, so it’s important to get on top of the situation as quickly as possible. First of all, if you are experiencing economic hardship, contact your lender to see if you can work out a deferment or forbearance. If your difficulties are temporary, you might be able to work something out, including a refinance or some type of car loan modification. If the hardship is of a more permanent nature, you might try selling the car quickly so that you can pay off your loan and avoid future hits to your credit score.

If the late car payment is the result of a mistake on your part, you might be able to call the lender and explain. Pay what you owe for that payment as quickly as possible, and then make your next car loan payment on time. It can help to arrange an automatic withdrawal from your account on the day your payment is due in order to avoid late payments in the future. (And remember, ReadyForZero can help you organize and pay off your debt!)

Your best bet, though, is to purchase a car that you can afford. Choose a loan with payments that you can easily afford — even if you end up with a financial emergency. That way, your car isn’t at risk, and it’s easier to maintain your good credit.

Why Higher Income Doesn’t Always Mean a Higher Credit Score

wealth

Imagine you’re faced with the task of predicting the financial security of two people. First, an individual earning minimum wage, with 3 dependents, and living in an expensive city. In comparison, the other is a millionaire living in a mansion in the hills. Equipped with a lifetime of funds they don’t seem to have a financial worry in sight.

If you had to guess who has a better credit score, would you have any idea? Low or high, depending on their personal circumstances?

The truth is, a higher wage does not indicate a higher credit score.

Surprised?

An article recently posted to MoneyTalksNews examined the relationship between high earnings and high credit scores and the verdict was definite: more money does not automatically mean better scores.

Though it can feel like those with a larger paycheck have it all figured out, having more money doesn’t necessarily translate into financial savvy. Everyone is susceptible to the ups and downs of financial turbulence regardless of wealth. Ultimately, it’s the choices you make with your money – as opposed to your net worth – that impacts your progress towards financial security.

When compared side by side, someone who makes minimum wage, pays their credit card on time every time, and takes measures to track that they’re not spending beyond their means could very well have a higher credit score than someone with a higher income who isn’t taking the same calculated steps. A late payment on a Corvette or Tesla is still a late payment.

More wealth does not a higher credit score make…

Even those with enough money to pay off all monthly bills aren’t exempt from forgetting to make a payment or making financial choices that negatively impacts their credit. And because credit depends on so many different factors, income is only a small part of the equation. Regardless of income, you can benefit from taking measures to protect your credit and build a solid financial foundation. Tracking your score, understanding the impact of opening and closing credit card accounts, and keeping a healthy debt/credit ratio are all important ways to maintain your score.

… but (and isn’t there always a but) it can help

There are some instances where a higher income can be beneficial to your credit. If you earn more, you’re more likely to be approved for a higher line of credit. The benefit? Lenders sometimes see a higher credit line as proof of greater financial security. This can be a double edged sword, however, if a higher line of credit ultimately prompts a higher line of debt. At the end of the day, good financial choices and habits aremore valuable than wealth alone.

Waiting for a higher salary to make financial changes?

If you’ve held back from cultivating good financial habits due to your financial circumstances, there’s no reason to feel limited. You have the power to make a positive change and you can start utilizing that power as soon as now.  If you’re looking to increase your credit score, you can start out by getting your free credit report and using tools and resourcesto help you out from there. Forming good financial habits is the real “wealth” in this situation.

It’s important to remember that everyone’s financial experience is unique. Good financial habits such as regularly checking in with your statements and progress, understanding the impact of interest, or researching what happens if you suddenly close a credit card, will help you to establish a secure relationship with your money. As a result, you’ll have a better read on your finances and a perspective that will empower you as you to work towards a stable financial future.

Can You Buy a Car With No Down Payment?

dashboard

Owning a car is basically a necessity these days. Most of us need it to commute to our jobs, take our kids to school and attend other social activities. But what happens if you need to buy a car right now but don’t have a down payment to put down?

The answer is that it can be tricky, but it’s entirely possible. The question is whether buying a car without a down payment makes sense for you – and whether you should even buy a car in the first place. Below, we’ll consider the pros and cons of buying a car with a down payment and highlight everything you need to know before making that kind of purchase.

1. Assess Your Financial Situation

The first step to take before purchasing a new car is to know the health of your financial situation and know how it will appear to the lender. This includes checking your credit report, verifying your income, and living in one place for at least a year if possible. All of these factors will give you a fighting chance when negotiating with a car dealer.

For example, if you have a very good credit score, you could get financed for a very low interest rate, saving you a lot of money in interest payments over the life of the loan.

Along the same lines, some auto lenders won’t allow consumers to purchase a vehicle without a down payment if they don’t have a good credit rating. So it’s important to know what you’re up against.

You can easily and quickly check your credit report online. Keep an eye out for anything that can affect your credit rating, like closing unused credit card accounts, which can shorten the length of your credit history and reduce your credit score significantly. Having a steady job or regular monthly income will also show the lender you’re a good candidate for a loan.

Regardless of your financial situation, see if you can avoid a long-term auto loan (i.e. stay away from 72 or 84 month loans as you will end up paying high interest rates).

2. If You Choose to Buy With No Down Payment, Shop Around and Negotiate

Some auto dealers will try to use tactics to trick you into settling for a loan with a high interest rate. But don’t be fooled. You don’t have to buy a car from the first dealer you interact with. You can shop around at other auto dealerships, as well as checking with local credit unions, or banks to see if you qualify for a better auto loan directly from them.

You also want to beware of being pressured into buying any extras when you purchase your care — like an extended warranty or credit life insurance.

3. Don’t Rush Into Buying a Car

There are some advantages to buying a car with a down payment (such as lower monthly payments), so it may be in your best interest to wait for a few months while you save money. Or at the very least, you may want to rebuild or repair your credit if it’s bad. This will help you avoid paying more interest and fees than you’d have to if you purchased with no down payment.

Imagine this: you buy a new car, but as soon as you drive the car off the parking lot, the value of your car depreciates by about 20% — in other words, your car is now worth 20% less than what you paid for it.

If you drive the car around for a month and realize you need to sell it, you’re probably only going to get about 80% of the asking price since the car has depreciated in value. If you made no down payment, selling the car will leave you with 20% of your loan unpaid without anything to show for it. This situation is called being “upside down” in a car loan and should be avoided if at all possible.

For that reason, if you’re buying a new car, it’s better to have at least a small down payment, versus none at all, to help counteract the depreciation that occurs.

4. Be Careful About Getting a Loan Cosigner

If you’ve done your research and aren’t rushing into purchasing, and still aren’t able to get approved for an auto loan, you might start to consider co-signing the loan with a family member. In that case, the car loan will end up in their name, with you as the secondary borrower. There are a few possible downsides to this arrangement. One is that if you miss a payment or default on the loan it will not only hurt your credit but also your cosigner’s credit. Having someone’s financial life relying on your own behavior can be stressful. Also, there could be a disagreement over how the car is being used and who is the true owner of the car. Getting into an argument over finances with your cosigner is not likely to be a very happy experience. If you absolutely must do it, then be sure you make all payments on time and keep all records organized and easy to find in case any disagreements arise.

The Bottom Line When You Buy a Car With No Down Payment

You can improve your chances of getting a low interest rate significantly by boosting credit history and proving that you’re a smart buyer. Don’t be afraid to shop around and save money while you negotiate with auto dealers. More importantly, if you can delay buying the car now, take some time to save money and build a better credit score – or look for a cheaper used vehicle. No one needs a top-of-the-line car; we just need something to get us from Point A to Point B.

If you decide to move forward with a purchase, do consider using a down payment of some kind. Any amount of down payment you put towards the loan will mean more money in your pocket every month and more of a chance of getting approved for a loan in the first place.