How to Avoid Car Loan Debt

How to Avoid Car Loan Debt

Purchasing a car can become a financial burden fast if you do not know how to avoid car loan debt. However, it is a vital investment for most.

A car loan may be your best choice to finance your desired vehicle. This type of loan is considered good debt because it enables individuals to invest in transport to earn an income.

To avoid car loan debt, you must assess your finances. A down payment is essential, but you can trade-in your existing vehicle instead. Consider how the loan period, vehicle age, and interest rate affect your repayments. During the term, you should pay larger amounts against the loan when possible, and refinancing may be an option.

However, since you must finance a significant amount of money, it can turn out to be quite burdensome. This is especially true if you cannot keep up with payments.

Therefore, it is vital to understand how to avoid car loan debt. This article will explore some of the ways you can lessen the financial load before and after you take out a car loan.

How to avoid car loan debt before buying a car

Knowing how to avoid car loan debt before you purchase a vehicle can protect you from an unbearable financial burden in the future. There are certain aspects of auto loans you should pay attention to before signing an agreement with a dealer or a financial institution.

If you have already purchased a car, then the following details may not apply to your situation. However, it is wise to keep them in mind should you consider buying another vehicle in the future.

The size of your down payment 

When you take out a car loan, you will be required to pay a portion of the vehicle’s purchase price upfront. This amount is referred to as a down payment.

One thing to note when learning about how to avoid car loan debt is that the size of the down payment you make affects your future repayments.

The down payment required on most vehicles is 10% to 20%. However, it can be less depending on your choice of lender.

Although 10% is the prescribed minimum amount, you should try to make a larger down payment, if possible.

If you wonder how to avoid car loan debt by making a sizable down payment, the answer is simple. You will need to borrow less if you pay more money upfront. 

Borrowing less translates to lower monthly or bi-weekly payments, depending on your payment frequency. And lower payments are, of course, more manageable. 

The age of the car

When looking into how to avoid car loan debt, you should consider the age of the vehicle you intend to purchase. While buying a brand-new car is ideal, purchasing a used car might be a better alternative to keep you financially afloat in the long run.

The reason being, that pre-owned cars are often cheaper than newer cars. If you buy a used car with an auto loan, you will need to borrow less than that for a vehicle driven straight off the showroom floor. Borrowing less will reduce your monthly payments, and there is less chance that debt will build up over time.

Not all used cars are necessarily in disrepair. You can find a used car that is in good condition. Aim for one that is not more than two years old.

The payback period

The time it takes you to pay off the financing you receive on your vehicle purchase is another factor to note when considering how to avoid car loan debt.

While a longer-term may seem ideal because your monthly payments are spread over several years, making them smaller, it is not advised. A lengthier period exposes you to a higher interest rate on your loan and the possibility of owing more than your vehicle is worth. In this case, you would have what is referred to as negative equity.

If possible, opt for a shorter payback period, such as 48 months or less. You will save on interest and pay off your loan quicker. Bear in mind, however, that you will incur higher monthly payments, but you will save overall.

The trade-in value of an old vehicle

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One way to lower your monthly payments is to utilize the trade-in value of your old vehicle. This would come into play when upgrading to a newer model. 

When you trade-in your car, you can lower the amount you need to borrow for a new car. Think of the vehicle you trade-in as a down payment. It will also reduce how much you need to borrow from a lender.

Make sure to spruce up your car on its interior and exterior before trading it in. To get an estimate of the value of your vehicle, check out local dealerships for the price of similar models.

The type of interest rate on the loan

When looking at how to avoid car loan debt, consider the type of interest rates you can have on an auto loan. There are two kinds: fixed and variable.

With a fixed interest rate loan, the interest you are pay remains the same from the start to the end of your loan term.

With a variable interest rate, the opposite is the case. You will often start with a lower rate than that on a fixed interest rate loan. However, you bear the risk of fluctuating interest rates in the future based on fluctuations in the prime rate.

While the interest going down on a variable interest rate loan is an upside, the downside is that it can go up. You could end up owing a significant amount of interest. And, without warning, it may be difficult to budget for it. This way, it can be harder to pay off your car loan, and your debt could increase over time.

A fixed-rate is best, but if you opt for a variable rate, make sure you fully understand what it entails before signing any agreements.

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Research and comparison

Two of the most important things to note when learning about how to avoid car loan debt are research and comparison between lenders.

It is best to shop around before choosing a car loan. Research and compare the lenders available to you by going online and obtaining different auto loan quotes. Alternatively, you can get quotes from dealerships via email or in person.

Compare the terms, interest rates, payback dates, and other details. In addition, there are online calculators you can use to get an estimate of your monthly payments.

This process will give you a reasonably good idea of how much you should budget for monthly payments.

The golden rule with car loans is never to overextend yourself. If you think you can do well with a particular loan, go for it.

How to avoid car loan debt after buying a car

Once you have purchased a car, it is time to repay the amount you borrowed along with interest.

There are a few matters to consider when thinking about how to avoid car loan debt after buying a car. Some may be an option for you, while others may not. But they all are worth considering if you want to ensure that you do not run into trouble with your loan.

Refinance your car loan

When you refinance a loan, you end your current loan agreement to start a new one. This could be with your existing lender or through a different lender.

If you consider how to avoid car loan debt by refinancing your loan, there are certain things to bear in mind. 

For instance, say you started with a high-interest rate because your credit score was poor. You may be able to negotiate for a lower interest rate later if you are up-to-date with payments. 

If your income has improved, you could reduce the loan term. This will increase your monthly repayments, but you would pay your loan off faster.

Make advance payments

Paying your auto loan off early is worth considering when looking into how to avoid car loan debt. The basic idea behind this is that you make lump sum payments towards your car loan when you can. 

Since interest is charged on the remaining balance, you will be charged less as you lessen what you owe. This can be helpful in the long run and keep you out of debt.

Note that, before making a prepayment, you should ensure that there is no prepayment penalty clause in your contract.

Paying an auto loan off early may not be an option available to most. But if you are in a position to offer a lump sum against the loan at any point, you should do so.

Obtain a debt consolidation loan

Are you paying off other debts such as a student loan or a credit card bill on top of your car loan? A debt consolidation loan may help you manage your payments and steer you away from overextending yourself.

Certain companies offer debt consolidation whereby they combine your multiple financial obligations into one easy-to-manage loan. Once you do this, you will only need to make one payment to the consolidation company. They will then redistribute the payment to your individual lenders.

Therefore, consolidation of your liabilities is one last thing you should consider when looking at how to avoid car loan debt. Consolidating your debt could save you a substantial amount of time and money over the long run.

The bottom line

Follow our above guide will help you avoid exceeding your limit over your car loan term. Knowing how to prevent car loan debt before and after you make a vehicle purchase can be beneficial in many ways. 

Be sure to consider the size of the down payment before you sign a contract. Also, consider the age of the car, the payback period, and the interest rate. If you would like to trade in your existing vehicle, ensure that you determine its value before doing so.  It is also essential that you thoroughly research and compare lenders before making a commitment. After that, you could consider refinancing your car loan, making a lump sum payment, or consolidating the debt to help manage repayments.

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FAQs about How to Avoid Car Loan Debt

What is a car debt?

A car debt is when you purchase a car and due to a financial burden, you are not able to pay off the car. To avoid car loan debt, it is recommended that you look at an overview of your financial position before taking up a car loan.

Is a car debt bad?

Yes. It’s not the best way spend your money on as cars depreciate the moment it gets driven our of the dealership. Not only that, it can also put your credit score at risk which can affect your loan application in the future.

How can I avoid a car debt?

You can avoid a car debt by being responsible and ensuring that you have enough money to make repayments. Usually 10% is the minimum amount but you should try and increase this as much as possible.

What else should I consider when it comes to car debt?

Look at the interest rate of the loan whether it’s a fixed interest or variable interest loan so you know what you’re up for before agreeing to any loan. For variable loans, when interest rates go up, you could end up owing a big amount of interest which makes fixed-rate loans better. Whichever you choose, just make sure you are fully aware of what it both entails before signing anything.

Should I refinance my car loan to avoid car debt?

Yes. You might be able to find a lower interest rate and low loan term. As a result, this can ease your payment and allow you to pay your loan off faster.

July 25, 2021
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