7 Warning Signs of a Bad Car Loan

Owning a car is a necessity, especially if you live in the United States. A car gives you more flexibility than public transport, a taxi, or Uber. However, most people aren’t able to purchase a car outright with cash, even a used vehicle. That means you will probably need an auto loan to finance the big purchase when buying a new car.

Unfortunately, not all auto loan lenders have your best interest in mind. Some lenders might mislead or fail to disclose essential details about the auto loan in order to profit more from the deal. These are acquisitive lending practices, and it’s important that you know the warning signs before you sign a contract. Knowing what a bad auto loan entails can help you avoid lenders that cost you a lot of time, headaches, and money. Here are a few warning signs of a bad car loan.

Too high interest rate

It’s essential to know how much the interest rate will be before signing a financing agreement. Moreover, the lender should honor that initial quote if you have been pre-approved for financing through a dealership.

Generally, customers with poor credit (a credit score less than 620) usually pay higher interest rates for financing than those with healthy credit. This is because lender always wants to be sure they will get their money back.

That said, some auto loan lenders might try to lock you into an interest rate that is too high than you should be paying. Don’t fall for this even if you have bad credit. Determine your credit score before stepping into a lender’s office, and use an online auto loan calculator to estimate how much you should be spending.

Exorbitant prepayment penalties

Paying off your loan earlier than expected is a great thing, right? It should be because it takes away from the interest charged. However, since lenders make most of their profit from the interest rate you pay on the loan, they don’t like it when you pay it off early. After all, the longer you pay the loan, the more interest they get.

While prepayment penalties are common across most lenders, they should be typically reasonable. If the prepayment penalty on your contract seems excessive, that is likely a red flag. However, keep in mind that some lenders might charge above or beyond what is reasonable, especially if you have bad credit and are applying for a subprime or high-interest loan.

Check with various lenders to get a rough idea of their prepayment penalties. You can also ask your lender to reduce it to something more reasonable but be ready to find another loan option if they can’t.

Poor loan repayment terms

Another warning sign of a bad car loan is a repayment term that is too long or too short. While an extended term can lower your monthly payments, you will pay high interest to finance your car. This could add up over time, and you might have to repay the loan for years. In the meantime, you won’t have the money to pay for other things, like monthly bills, regular grocery spending, and other expenses.

On the other hand, short repayment terms will cause you to pay more interest since you will only be paying a smaller amount each month. However, you will have to pay more in interest in order to pay off the loan faster.

Generally, a good auto loan will have a repayment term between 5 and 7 years. That way, you won’t be paying too much interest, and the car loan payments will be more manageable.

A mandatory arbitration clause in the fine print

You essentially have no legal resort when you sign a mandatory arbitration clause. It doesn’t matter whether the loan terms are different from what you agreed upon or whether your lender signed you into a fraudulent car loan.

Once you sign the contract, you won’t be able to sue the dealership or lender. Instead, you will be forced to take the complaint to an arbitrator, which usually means an uneven playing ground for the client. A closed-door meeting may lead to transparency issues, and you might get stuck with an adverse take-it-or-leave-it decision.

Lenders are not always direct about the fine print. Therefore, read the contract carefully, including the fine print, which is where it is normally hidden, and specifically ask whether the contract includes an arbitration clause.

The car’s price is not what you agreed to

Perhaps you have finally found a vehicle that fits your lifestyle and meets your budget. You come into agreement with the salesperson on the dealership lot, but all that changes when you are handed the final price of sale.

While the dealership might try to blame the price difference on administrative fees or the salesperson making an unauthorized sale, take this as a red flag. And if you are uncomfortable with the final bill of sale, walk out. You have no obligation to finance a more expensive car than you expected.

You should also say no if the dealership tries to sell you a vehicle for more than its advertised price. In most states, a verbal or written car price agreement is assumed to be the total price of the vehicle, including fees. Thoroughly read the contract before signing it, and do some research on vehicle pricing before visiting a dealer.

Your contract is a conditional sales agreement

Conditional sale car finance only benefits one party: the dealership. Also known as yo-yo sales, conditional car financing allows the dealership to cancel the sale if the loan terms don’t meet their requirements. This can even happen when you have driven the car home.

In most instances, the customer believes they have undertaken all the necessary steps and finalized the purchase only to receive a call from the dealer claiming they can’t honor the sale agreement since they could not fund the loan. This often results in the customer returning the car to the dealership and renegotiating a more costly loan.

Be sure to report to your local consumer protection office if you encounter such an unethical practice. In your contract, make sure you look for terms like conditional delivery, conditional financing, or spot delivery and ask the dealership to clarify what the terms mean.

Loan packed with junk fees

Some dealers with in-house financing might try to increase the cost of an auto loan by signing you up for costly and unnecessary add-ons. Of course, there are some legitimate charges you should expect to see in your contract. These include things like sales tax and documentation fees.

However, charges for extended warranties, rust control, fabric protection, VIN etching, floor mats, and other add-ons are typically just deluxe charges. Unless you agree to these products and services, be sure to ask them to be removed.

Read through the entire contract before signing it and ensure you understand every charge. Question any charges you are unsure of or you think are bogus.

Summing it up

Buying a new car is one of the most expensive purchases you can make. Therefore, it’s always a good idea to carefully consider all options before you sign for a car loan. Doing so will help you find an auto loan that suits your needs and is within your budget.

Generally, the best loan option when buying a car is one with the lowest interest rates and shorter repayment terms. Follow these rules, and you are sure to find a car loan that works best for you.