Car loans are a type of secured debt. Lenders use the car as collateral when writing the loan, and if the borrower defaults, the lender assumes control of the vehicle. Some people use home equity lines to purchase vehicles in which case the collateral for the debt is the borrower's home rather than the car.
History
Before the the mass production of cars became commonplace, car dealerships paid cash for vehicles and sales were scarce. After World War I, production increased and General Motors established its own financial services arm; General Motors Acceptance Corp. In 1959, Ford founded the Ford Motor Credit Co. LLC, and later in the 20th century other manufacturers including Honda and Toyota began to offer vehicle financing. Many banks have dealer services divisions that provide wholesale lending services to automobile dealers, and banks also lend to individuals.
Time Frame
Most banks allow customers to borrow only against cars that are less than seven years old. Banks regard vehicles as depreciating collateral and do not want loan terms to extend past the useful life of a car. Car payments are due monthly and normally begin 30 days after the purchase of a vehicle. Short-term car loans of three years or less have lower interest rates than longer-term loans because the car has less time to lose value.
Misconceptions
Many people mistakenly believe that they can co-sign on a vehicle without assuming responsibility for the debt. Co-signers are liable for the debt if the principal borrower defaults on the loan. The payment history of the loan is reflected on the credit report of both the borrower and the co-signer. Banks allow individuals without an ownership interest to co-sign for cars, and many parents do so for teenage children.
Considerations
Credit unions and small banks tend to offer better rates for car loans than large banks. Small financial services companies have limited deposit bases and are more averse to taking on large risks such as commercial loans or jumbo mortgages. To generate profits they offer small loans such as car loans because two or three car loan defaults would have less impact on their financial stability than one large mortgage default. Small banks offer lower rates to lure clients from large competitors who focus on lucrative home lending.
Warning
People who buy cars with home equity lines often cite the tax deductions offered on home loan interest payments as a key factor in the decision. Home equity lines have variable interest rates, and when interest rates are low, they may result in lower payment amounts than car loans, but the rates rise every time the prime rate increases. Many people do not realize that HELOC payments are interest-only and rates can rise as high as 20 percent.
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