How to Manage a Car Loan

The keys are in your hand and the car is yours. But your work's not done -- you still have to manage that car loan.
The keys are in your hand and the car is yours. But your work's not done -- you still have to manage that car loan.
Barry Austin Photography/Getty Images

You've done your homework, you've negotiated a car loan and now you're driving off the lot in your new set of wheels. Well, it's not exactly your new set of wheels. Until you finish paying off your 36-month, 60-month or 72-month loan, that car belongs to the bank, car dealer or credit union that fronted you the cash in the first place.

Luckily, when handled correctly, paying off a car loan is a simple and painless process. If you've picked the right car, figured out the best monthly payment and kept a close eye on your finances throughout, you'll be a full-fledged car owner in no time.

A successful car loan is a great way to build up a solid credit rating and set yourself up for a long future of mortgages and small business loans. And, of course, once the car is paid off, it's all yours. You can sell it, trade it or hang on to it for many happy years of fun, debt-free motoring.

In this article, we'll look at how to smoothly pay your way through a car loan, and even how to change loans mid-stream in order to get a better deal. After all, sometimes the car loan that made sense at the time of purchase may need to be reconfigured.

We'll also take a close look at what to do if things start to go wrong. When the money dries up, a shiny new car can suddenly become a very expensive liability. We'll look at some last minute schemes to keep your head above water.

But first, you've got to start budgeting. Keep reading to figure out when to pay, how to pay it and how to pay as little as possible.


Manage Your Car Loan by Making a Budget

The first step to managing your car loan is to see how it fits in your overall budget. If you've gotten a loan, you're already locked in on a set payment each month. Write down all your other monthly expenses (mortgage payments, food, entertainment expenses, etc.) and weigh those against your monthly auto payments. Auto payments should be a comfortable, manageable portion of your gross income. If you find yourself making undue sacrifices to pay off your new vehicle, you may want to consider getting a cheaper car. Using an online "loan calculator" can help you plot a monthly budget.

Keep in mind that it takes much more money to keep a car running than simply paying off the loan. On average, the total cost of car ownership is around 1.5 times higher than the cost of paying off the loan [source:]. Remember to budget for insurance, gasoline and regular maintenance such as oil changes and new tires.

Most consumers spend about 11 percent of their monthly income on car payments [source: Sahadi].In some cases, that percentage can balloon as high as 15 to 20 percent [source: Weston] By comparison, the monthly food expenses of an average American household are only 12.4 percent of total income [source:]. Hopefully, you were prudent when applying for your auto loan so that your monthly payments are about 8 percent of your monthly income.

An easy way to make sure you pay your car payment on time is by selecting the most convenient payment method. You may choose to pay online, or by mailed check, or even in-person at the financial institution. But if you're looking for the quickest and easiest method, consider setting up an automatic payment plan. Under this plan, a set amount is automatically drawn from your bank account every month. Provided you keep enough cash in your account, an automatic payment plan ensures that you can avoid the credit dips and late fees associated with late fees. Many institutions will even reward an automatic payment plan by charging lower fees.

Simply put, the faster your pay off your loan, the more money you'll save. Hopefully you were able to pay a substantial down payment, but if not, it's still possible to speed up the term of a loan -- as long as there are no penalties associated with early or extra payments. Four-fifths of all car loans in the United States last longer than four years -- a worrying sign for an increasingly debt-ridden populace [source: Healey]. Plan to pay off your car within 48 months at the most. Any longer, and it might be a good idea to start considering a cheaper car.

Should an unexpected cash windfall ever come your way, it's a good idea to put it toward paying off your car loan. Your car will be free and clear much quicker, and you'll save interest in the long run.

Keep reading to find out how you can swap out your original loan for a better deal.

Refinancing Your Car Loan

After driving your car for a few months, you might start to feel uncomfortable with your original loan. Maybe you got your loan from the dealer, and now you're finding yourself paying steeper-than-average monthly rates. Or maybe interest rates have dropped, or your credit has improved, meaning that you'll be able to secure a loan with better terms.

If any of the above is true, it's a good time to start thinking about refinancing your car. First things first, check to see if the car is worth more than the amount you owe. Do this by checking the value of your car in the Kelley Blue Book and comparing it to how much is owed on your loan. If your car is worth less than what you owe, you are said to be "upside down." Basically, being upside down means that your car is depreciating faster than you're paying it off. Should that be the case, your best bet is to hang on to the car and try to pay off the loan as quickly as possible.

If, however, your loan is still "right side up," you might consider refinancing. Start by shopping around for a better loan. If you obtained your loan with an auto dealer, you'll likely want to consider refinancing with a bank or credit union. Car makers make lucrative amounts of money off their financing schemes. Ford, for instance, generates more than 80 percent of its revenue from vehicle financing [source: Bradford].

If you already have debts tied up with a bank, the bank might be able to offer you the best refinancing rate. Credit unions, on the other hand, are non-profit and member-owned, which means you'll typically end up paying less than at a bank. Although credit unions are only responsible for roughly a fifth of all U.S. car loans, a credit union can typically offer rates up to 1.5 percent lower than banks [source: Credit Union Direct Lending, Dratch].

It's not always necessary to finance your auto with a tailor-made auto loan. You could decide to refinance with a home-equity loan. You'd get a lower interest rate, and the interest might be tax deductible. However, a home equity loan can also subject you to higher fees and increased risks: If you default on your car payments, you might be forced to sell your home.

When searching for refinancing, be careful not to shop around too much. If you inquire at more than three financial institutions, it could end up diminishing your credit score.

Read on to figure out how to conveniently bundle your car loan with other debts, and save on your interest payments at the same time.

Consolidating Your Auto Debt

Behind on your car payments? Is your car sporting a tree-shaped air freshener? Then this guy could be called Otto or Bud, and he's looking for you.
Behind on your car payments? Is your car sporting a tree-shaped air freshener? Then this guy could be called Otto or Bud, and he's looking for you.

Like most consumers, you're probably paying off a few other debts in addition to your car loan. Mortgage payments, credit card bills, boat payments -- if only there was a way to tie all these debts together into one, easy, monthly payment.

Welcome to the world of debt consolidation where you take out one big loan, and use it to pay off all your smaller debts at once. Do it right, and you can end up saving a good chunk of money per month. Do it wrong, and you could find yourself paying out much more than before.

The first benefit of a loan consolidation is convenience. By streamlining your debt, you lower the amount of bills in your mailbox and simplify your monthly budget. Secondly, just as with refinancing, a consolidation may allow you to pay a lower, overall rate of interest. People with high-interest credit card debt are particularly drawn to loan consolidation, but consolidation may also make sense for your car loan if you walked out of the bank/dealership with a particularly costly financing scheme.

Overall, you should only consider debt consolidation if your credit rating is in relatively good shape and you have no trouble paying off your existing loans. A consolidation loan is a big commitment, and a financial institution is unlikely to grant it unless you can prove that you're good for the monthly consolidation payments.

Before you consolidate, remember that your debt consolidator may also be less understanding than your individual creditors. Your auto loan lenders may be more than willing to ignore the occasional late payment or negotiate an alternative payment schedule if you hit hard times. A bank, on the other hand, might be more prone to send in the debt collectors.

And, by mixing together all your debts, all your assets are now equally at risk. With a simple car loan, if you default on your car payment, a lender could repossess your car - but wouldn't have any title to your house. A consolidator, however, can go after your car, your house, your boat -- anything you've included in the consolidation scheme.

If your finances are a little shaky, be extremely wary of any institution that offers you debt consolidation. Stressed, debt-ridden consumers are easy prey for shady debt consolidators. One trick is for consolidators to lower your monthly payment, but dramatically increase the interest rate and the terms of payment. You'll be paying less per month, but you'll be paying for much longer, and with interest rates as high as 20 percent [source: Dunleavy] Be wary of any debt consolidators that charge high, up-front fees, or promise outlandish offers like 0 percent interest or "instant" debt relief.

If you're unsure about whether to consolidate, consider calling up a non-profit credit-counseling agency.

Should you get struck by lightning or lose all your money at the racetrack, keep reading to find out how to work around a payment default.

Car Loan Default

Whether it's due to job loss, divorce or even an accounting error -- the day might come when you'll default on your car payments. Every loan will have its own rules regarding a default, but in most cases, a default can prompt an immediate repossession of your car.

Across much of the United States, defaulted cars can be seized from your property without notice -- at your expense. As long as repossession agents return the personal belongings found inside the car, the procedure is completely legal.

Once your car has been repossessed, you may be able to get it back by paying off the balance of the loan -- as well as any towing or storage fees. Failing that, the lender will usually decide to sell the car at auction.

Even after the car is auctioned off, you may still find yourself owing a "deficiency." Say that you owe $5,000 on a car that gets repossessed. If the creditor sells the car for $3,500, that means you still owe $1,500 on the car. Lenders may decide to sue you for the remaining amount.

Defaulting on an auto loan is extremely damaging to a credit rating. Following repossession, it may take up to 7 years before your credit rating is stable enough for you to obtain another loan [source: Melo].

So, what should you do if you find yourself thinking of tree air fresheners, Harry Dean Stanton and Emilio Estevez, and all of a sudden someone says, "Repo Man"? Hot foot it over to the next section to find out.

How to Deal with a Car Loan Default

When you start to see a default looming on the horizon, try to sort it out long before tow trucks start showing up in your driveway. First off, you can try to renegotiate your loan. Many creditors would rather work out a deal with you than go through the hassle of repossessing and reselling a car. Give your creditor a call, explain your situation and work out an alternative payment plan. If you wait until after your car's been repossessed, it's likely to be too late for negotiations.

Alternatively, you can sell the car on your own, and use the proceeds to pay off the remainder of the loan. This will save you the hassle of repossession and avoid a mark to your credit rating. However, since you don't technically have ownership over your car, you'll have to check with your lender about how to arrange a sale. In some cases, the lender will require a direct payment from the buyer before it will release the title to the car. And be sure to sell the car yourself without using an agent. You'll make more money, and be in a better position to fully pay off the loan.

If you are "upside down" on your loan, you may have to conjure up a bit of extra cash after selling your car. If you don't have the money on hand, you may be able to do this with a personal loan, home equity loan or by borrowing from your retirement fund. Friends and family, if asked very nicely, can also be persuaded to pull out their checkbooks to spot you for a loan deficiency.

If all else fails, consider a "voluntary repossession." Drive the car to your creditor and hand over the keys. You'll still owe the balance of the loan and you'll still have a damaged credit rating -- but at least you'll be spared the expense of a professional repossession. 

Related How Stuff Works Articles


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