That shiny new car would sure look great sitting in your driveway, not to mention the impression it will make on friends, relatives and coworkers. The problem is that the only way you are able to afford to buy it is by taking out a loan. While vehicle financing allows you to buy a needed means of transportation without saving up the whole purchase price ahead of time, it can pose potential short-term and long-term problems.
As with virtually any type of loan, a car loan requires you to pay interest in addition to the principal, effectively raising the total cost of the car above the sticker price. Your interest rate will depend on a number of factors, such as your credit history, the lending institution and economic conditions in general. If poor credit results in a higher interest rate and higher monthly payments, you may need to stretch out the payments over a longer time period to make them more affordable. Unfortunately, this means you'll pay even more in total interest over the course of the loan.
Financing a vehicle can make it easy to bite off more than you can chew. When you're in the dealer's showroom, it can be a challenge to avoid the temptation of purchasing a more expensive car than you can truly afford. You might rationalize the higher monthly payment at the time by deciding to cut back on saving and investing. Consequently, your long-term financial outlook may suffer accordingly.
When you finance a vehicle, you're probably buying a brand-new or late-model used vehicle with a relatively high value, so your auto insurance premiums may also be higher. Additionally, your financing company may require you to carry higher liability and physical damage coverage than you normally would to protect its interests. If you're in a position where you owe more on the vehicle than what it is worth, which can occur quickly due to depreciation, you may also need to purchase gap insurance to make up the difference in the event of a total loss.
Auto financing is a form of secured loan, meaning you must agree to put up the vehicle as collateral to gain approval for the loan. It also means that if you fall behind on your payments, you might look out your window one day and see a tow truck hauling the vehicle away. In addition to having to find a new way to get to work, a vehicle repossession puts a black mark on your credit history than can last for several years.
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