Pros and Cons of Auto Loans: Is It Worth the Risk?

auto loan

‍When it comes time to purchase a car, you might have several car financing options available to you. Auto loans can be an excellent way for you to get the car of your dreams without having to sacrifice anything in terms of monthly payments or upfront costs. However, auto loans come with several pros and cons that you’ll need to evaluate before making a final decision on whether this is still the right choice for you. In this article, we’ll take a look at some of the pros and cons associated with auto loans so that you can make an informed decision about how you want to proceed with your car-buying process.

What Is an Auto Loan?

An auto loan is a type of financing that allows you to purchase a car while making monthly payments to pay down the full amount of your auto loan. You’ll typically be given a set interest rate, repayment amount, and length of time to repay the loan. An auto loan is typically used to purchase new or used cars or commercial vehicles such as trucks, RVs, and boats, although, there are some exceptions to this rule.

You can also use an auto loan to refinance an existing car loan if you would like lower monthly payments or a longer repayment period. That said, it’s important to note that you will likely have to pay a higher interest rate with an auto refinance than if you were to get a new auto loan.

Advantages of Buying a Car on Loan

You can get a car as soon as possible to solve your urgent needs

When you urgently need a car for convenient travelling with your family, to facilitate your side business, or to help you get to work earlier but you’re low on cash, taking out an auto loan gives you the chance to get your car now. Before you take out an auto loan, you’ll first need to create a budget to determine how much in monthly loan and insurance instalment payments you can comfortably afford to make so that you don’t find yourself struggling to make payments. 

Once your budget is ready, find an auto lender whose overall terms of payment such as interest rates and structure and other associated costs meet your financial needs.

Saving for a car could be a tall order if you don’t have other buffer savings 

Saving for a big purchase could mean years of saving and a high saving discipline if your income is on the lower side.

Your savings will be more successful if you already have a separate emergency savings account or insurance cover to cater to emerging business or family needs. Without a savings buffer, you may find yourself digging into your car savings on rainy days, delaying your goal of becoming a car owner. 

You can consider saving for a few months to make a large down payment on an auto loan, instead of struggling for years to save the entire car purchase amount. Making a large down payment may qualify you for an affordable, low-interest loan and you can drive your dream car sooner. 

You can get 100% financing on a new, more reliable car

Many cash buyers likely buy older and cheaper car models. But older cars are generally less reliable. For example, if you buy a car with high mileage and little record of repair and maintenance, you could find yourself overspending on repairs, maintenance, and insurance before you even have a chance to enjoy your car. The cost of repairs may also exceed the car’s value at some point and you’ll soon discover that you’re better off without the car. 

There are cases where a dealer may also lie about the history of an old car by, say, altering its mileage to a lower one so you end up getting a raw deal. Unless you can identify a trustworthy dealer for an old car, you may prefer to opt for a new, more reliable car. New cars are much more expensive but the good news is that some lenders like Mwananchi Credit Ltd offer 100% financing on new cars, which can be a good deal if you are low on cash and need a reliable car that will serve you for many years to come. 

You can save your cash for rainy days or make profitable investments

Buying in cash is not always a good idea even when you have the cash ready.

You could end up cash strapped in case of a business or family emergency. Instead of pouring all your savings on a car, you could take out some cash and make a huge down payment so that you’re left with a smaller loan to pay and possibly qualify for a lower interest rate. 

You may also put the extra money into profitable ventures like rental property or starting or expanding a business. If the return on your investments is more than your auto loan interest, you could come out on top even if you are paying interest. 

Disadvantages of Taking a Car Loan

Car value depreciates fast

Your car loses approximately 10% of its value the moment you drive off the lot. If you’re financing an older car, the value goes down even faster and you could end up with negative equity, a situation where the loan you owe is much more than the value of your car.  

For instance, if you owe Ksh 900,000 on a vehicle currently worth Ksh 600,000, then you have Ksh 300,000 in negative equity. This situation mostly happens when you make zero or a small down payment or your interest rates are too high.

While you continue to enjoy your car, this negative equity becomes a problem when you lose your income and can no longer make payments.  You’ll not be able to repay the loan even if you sell your car. Lenders may also not want to refinance your loan and you’ll have to find extra money to cover the negative balance before you can be open to better financing options. 

You can also do a car trade-in and take on a new loan, but that leaves you with more monthly payments to make as the new loan may include your previous outstanding negative loan balance. 

You end up paying more for the car overall

The process of car financing involves lots of extra costs. These costs vary from lender to lender and may include excise tax, car valuation costs, processing fees, late payment fees, disbursement fees, credit life insurance, and the cost of installing a car tracker.

You may also end up paying very high-interest rates on your car loan, for instance when you: 

  • Are financing an old car
  • Make zero or a small down payment
  • Have a longer loan tenure of, say, more than 5 years which can also put you outside your car warranty and expose you to expensive repairs
  • Have a poor credit or income history and the lender considers you to be a high-risk loaner
  • Choose a lender with a fixed interest rate structure instead of a reducing balance structure 

With all these costs combined, it’s easy to find yourself paying much more than the cash value of your car in the hundreds of thousands. 

You own the car jointly with your lender

A car on loan jointly belongs to you and the lender until you pay your car in full. You have to put up with issues like car tracking and mileage limits imposed by the lender which can limit the way you might want to use your car. 

You also risk car repossession when you default on your car payments. Repossession often comes with additional fees to you such as the cost of sending a repossession agent, towing, storage, and auction fees. All these costs can go upwards of Kshs 15,000, interfering with your budget. 

Tips to Navigate Car Financing Challenges and Get the Most Out of Your Loan

You can overcome or avoid the challenges that come with taking a car loan. Here are some tips to help you navigate auto loans:

  • Save for a large down payment to reduce your loan obligation, which may help you qualify for lower interest rates and avoid a situation where you have negative equity on your vehicle
  • If you find yourself with negative equity, find some cash to pay out your negative equity and refinance your loan to get lower rates. With a lower rate, you may be able to clear your loan obligation faster
  • You can increase your monthly loan payments to clear the loan faster if your income increases during the loan period. Find out if this will result in an early payment penalty from your lender first and weigh the options to determine if it’s worth making larger payments
  • Choose the best lender that matches your financial goals.
  • You can use your car for a side hustle or other money-making opportunities to make extra money towards your instalment payments
  • Refinance or renegotiate your loan for better loan terms when you get stuck

The Right Car Loan Should Match Your Financial Needs

It’s great if you can buy a new car but taking a loan is also a worthy option if you can’t afford to buy a car in cash, for instance, if you urgently need a car or you prefer to buy a new car. At times, taking a loan is better than buying cash because you get to keep your savings buffer for a rainy day or invest the money in more profitable ventures. 

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