Car loans are really not that complicated: All we want is to keep costs as low as possible. No wonder so many dealers are trying to outbid each other with the cheapest loans. It is also why you still see those notorious 0% deals everyone is warning you against.
If there’s a way we can save some money, we’ll take it. It’s as simple as that.
At the same time, fixating yourself exclusively on costs can be dangerous.
Far too many drivers default on their loan and have to watch their car get repossessed.
Quite often, seemingly attractive car loans are to blame. In this article, we’ll explain why that is. We’ll investigate two basic approaches to car loans and point out their respective benefits and disadvantages.
It may sound absurd. But it can sometimes be better and safer to opt for a slightly more expensive option.
As any expert will tell you, you need a strategy when buying a car.
It doesn’t matter if you’re looking for a new or a used car: Without thinking everything through, setting up a plan and then acting upon it, you’re lost.
When it comes to securing a car loan, there are essentially two fundamental approaches. Which of these you chose is as much a matter of taste as it is of budget. In fact, it is a lot more than that. Which of the following you chose may decide whether you’ll enjoy your car for many years to come or end up having to default on the loan and return the vehicle.
- Approach 1 / Total costs: By choosing this option, you aim at keeping the costs low. The easiest way to achieve this is to pay the loan off as fast as possible.
- Approach 2 / Achievable monthly payments: This approach to car finance is all about safety. Your main concern is to keep monthly payments at a realistic, manageable level. You will, however, need longer to pay the loan off. You’ll also pay more.
Conceptually, neither of these approaches is rocket science. But which is best for you?
Focus on: costs
Let’s take a look at approach 1 first. This is by far and wide the method favoured by experts and journalists who have written about the topic.
These are the pillars of the approach:
- Make a down payment to reduce the total loan sum.
- Aim at a short loan term. Most agree that you shouldn’t take longer than four years before the vehicle is yours.
- Try to keep monthly payments as high as possible. This actually ties in with the previous point, because you can only pay the loan off quickly if you stick to a tight payment schedule.
So how would a dealer approach this?
This is what the process would look like in practise:
- In a first step, the lender sets the loan term. Concretely speaking, he works out how long you’ll take to pay off the entire debt on the vehicle.
- In a second step, you establish what interest rate and monthly payment this amounts to.
- The total costs are then a function mainly of the loan term.
It is easy to see why insiders recommend doing things this way: It can potentially save you a lot of money!
How much can you save?
There are plenty of car loan calculators available online. If you’re looking for a deal, these are great tools. They allow you to play with the numbers and run through a few options. This allows you to understand how reducing or raising your monthly payments affects overall costs.
Here’s an example of what this look like in practise:
Let’s say you want to borrow £5,000. If you pay off the loan in 5 years (or 60 months), your monthly contributions will be slightly over £95. The total amount payable is £5,790.89.
Now, if you can chip in about £50 more each month, you will be able to pay your debt off in just three years. The total amount now stands at £5,470.72.
So you’ll have saved £320.
Don’t forget the interest rate
Of course, these numbers are merely theoretical. In reality, you should be able to shave off even more. If you make a deposit and opt for a shorter loan term, your APR may drop even more, making the loan still more attractive.
Also, if you have a better credit rating, this, too, will help keep loan costs low.
This all sounds great. So, you might ask, what’s wrong with it?
The problem with low total loan costs
To understand why focusing only on keeping your car credit costs as low as possible, you need to look at risk distribution.
To visualise this, imagine a seesaw. You’re sitting on one end and the lender on the other. The seesaw will tilt to one side or the other depending on who carries the weight of the risk.
If you have a bad credit rating and no financial reserves, or if you can not make a down payment and want to pay the loan off very slowly, the lender carries most of the risk. Accordingly, the seesaw will tilt all the way to his side.
If, however, you agree to pay the loan off quicker, pay larger monthly instalments and can make a down payment, the risk tilts more to your side. The lender will ‘reward’ this with a reduction in loan costs.
So the faster you pay off the loan, the cheaper it gets. At the same time, the the risk of you defaulting on your loan will be higher. This is easy to understand: If you pay more towards you loan, this leaves you with less for other things.
This is why approach 2 is quickly winning over new fans
With this approach, the process is different right from the beginning:
- The first thing you do is work out how much money you can pay towards your car loan each month.
- In a second step, you establish what loan term and interest rate this amounts to.
- The total costs are now mainly a function of monthly payments.
So the logic is reversed. You act as though you don’t care about the total costs, but only about how much you can actually pay. As a result, car finance costs will inevitably be higher.
If we return to the seesaw image again, this approach establishes more of a balance between the two sides. You reduce your risk. But so, too, does the lender, since the chances of you defaulting are now lower.
But … does it make sense?
The answer to this question depends on your point of view.
As we already pointed out in the very first paragraph, none of us has any money to give away. So no one particularly likes to spend more than they absolutely have to.
But consider this:
- If you’re having financial trouble, it may be a lot safer to focus on monthly payments. This will take longer and be more expensive. But if it saves you from having to go into insolvency, maybe it’s worth it.
- Sometimes, the lender simply won’t accept a cheaper payment schedule. Instead, he will want to keep the risk of the exchange low and thus propose to extend the term a little bit.
So, very simply, approach 2 makes it possible for those with a bad credit history to get behind the wheel again. Experts may disagree this is the best way to do it. But thousands and thousands of happy drivers have already proven them wrong.
Car loans at iFinance: How we do it
At iFinance, it’s all about finding individual solutions. This means that we like to avoid generic approaches which seem simple but only end up making things complicated.
- If you can make a deposit, great. In case you can’t, we’ll work it out.
- If you want to take your time paying off the loan, that’s perfectly fine with us.
- And if you want to go faster, we’ll check if that’s possible.
In any case, there’s a very good chance that you can drive home in a great car the very same day.
We look forward to hearing from you! Give us a call at 0141 848 7733 and visit our digital showroom to see what models we have in store for you.