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Can You Use A Student Loan to Buy a Car?
Many students find themselves in the predicament of needing a car but not having many financing options — particularly if an international student car loan isn’t in the cards for them. This is especially true if you are a foreign student studying on an F-1 visa. It can be tempting to use your student loan for a car, but although that might be a quick solution it is definitely not the smartest one.
Car Loans for College Students
College students also need reliable transportation. What do you do if you don’t have access to reliable public transport? Have you thought of a car loan? Buying your own car through a car loan will open up a world of possibilities for you. This is what you need to know about car loans for students.
Car Loans Explained
Car loans are also called closed-end deals. It means you’ll borrow a specific amount of money to buy a car and you won’t be able to increase the amount once you’ve accepted the deal. Your car loan has an interest rate and you need to pay a fixed monthly installment until the car loan has been settled. Most loan agreements require you to return the vehicle when you fail to make payments.
Make sure you’ll be able to cover the monthly installment and don’t buy a car that is more expensive than what you’ll need. Your credit request will be rejected if you apply for a car loan that is beyond your credit score or financial means.
What Is a Down Payment?
Lenders are afraid to risk credit offers on the value of something like a car. Cars can lose their value pretty fast. So, lenders require you to make a sizeable down payment when you take out a car loan. It’s like paying an upfront deposit. In that way, the value of the loan will not exceed the value of the car. It’s used to prevent the total debt from rising above the total value of assets. Having more debt than assets makes you insolvent and is bad for your wealth.
Making a larger down payment on your car loan also helps to lower the interest rate on your loan. A lower interest rate leads to cheaper monthly payments which help to lower your monthly expenses.
Why Leasing a Car is a Bad Idea
The best possible way to get a car is to buy it in cash. Unfortunately, most people don’t have the privilege of being able to do that. So, lenders have come up with clever ways to help people own cars. This poses the question of whether buying or leasing a car is the better choice. Leasing a car would make perfect sense under the right circumstances. But it isn’t always a good idea for a number of reasons:
- No Underlying Value
- Stringent Terms and Conditions
- Ownership and the Possibilities It Brings
Let’s take a look at why leasing a car (versus buying one with a loan) is not such a good idea. We’ll show you why it could be to your advantage to rather buy a car than lease it.
No Underlying Value
Leasing a car is like paying for your gym membership. You don’t own the gym but have the right to use its facilities. Plus you lose access to the gym the day you stop paying your membership fee. Leasing a car works the same. You pay for access to the vehicle but you don’t own it. And, the day you stop paying you must return the vehicle to the dealership.
This is where the first problem starts. Let’s assume you lease vehicles for the same amount of time it would have taken you to repay a car loan. You pay thousands of dollars for something that you don’t end up owning and so add no value to your wealth. Sure, a car is not a conventional asset like property. But it could still have been a piece of machinery you own had you rather opted for a car loan. Leasing a car does not grant you any ownership rights and therefore does not provide any additional value other than being able to use it.
Stringent Terms and Conditions
You are using someone else’s property. Unfortunately, you can’t make the rules regarding the vehicle even though you pay for it. Many leases have confining terms and conditions written into the lease agreement. You’ll also need to pay all kinds of expensive penalties if you breach the agreement. This would not have been a problem if you owned the car you drive.
It could even be possible that your needs with the car cause you to regularly breach the terms and conditions of your lease, which will result in quite a few penalties on top of your monthly lease. If this is the case, you could even have saved money if you’d rather opted to buy a vehicle with a car loan.
Ownership and the Possibilities It Brings
When you lease a car you are at the mercy of your dealer. They have the ultimate decision about your vehicle. But, if you own the vehicle you can make your own decisions. It’s possible that you can get a very good price for the car you bought. You can now trade that car in at a dealership for a more favorable deal or you can sell it and use the proceeds as you want to. Owning the vehicle makes you the boss and places all the power in your hands. You’ll have many more options and greater possibilities if you own the vehicle rather than leasing it.
Is Using Student Loans to Buy a Car a Bad Idea?
Ask any financial guru and they will tell you that it is a really bad financial strategy to use your student loan for a car. On top of that, if you are using a federal loan it is illegal.
Federal student loans offer lower rates than other private student loans as they are backed by the government. Due to the lower interest rate, these loans carry more restrictions. The purpose of federal student loans is to cover the cost of higher education such as tuition, books, living cost, transport etc. Federal loans explicitly exclude cars. When taking out a federal loan you have to agree that the money you get will only be used for the above-mentioned expenses.
In addition to not being allowed to use your federal loan to buy a car, it is really a bad idea to buy a car using your student loan.
The fact that you only start paying off your student loan after your studies might make this an appealing option as opposed to taking out an auto loan. What you have to remember is that interest still accrues on the loan in the years that you are not making any payments and while interest is accruing your car will be losing value.
There are also other factors why you should not use your student loan to buy a car.
Personal Loan Options for Students
If your credit score isn’t looking too bad you can possibly take out an auto loan or private loan to buy your car. Even if you are a foreign national studying on an L-1 visa, you also have loan options (through companies like Stilt) to buy a car.
Your credit score will play a big part in your loan application and the rate you will get. A credit score between 661 and 850 is considered favorable (or “prime”), 601 to 660 is neutral and 500 to 600 is considered “subprime”.
What should you do if you are considering taking out a loan to finance your car? Here are a few important things:
- Check Your Credit Score
- Assess Your Monthly Budget
- Assess Your Monthly Payments
Each of these items is explained in more detail below.
Check your credit score
You can get a free credit report from TransUnion, Experian, and Equifax or on a website like AnnualCreditReport.com. You can also pay one of the credit bureaus to get your actual accurate credit score.
The credit score on these reports might not match the one the lenders give you exactly (as they might use a different scoring model) but it will definitely give you a good estimate of the credit score tier you fall in.
Once you know what tier you fall in, you can estimate what rate you will be able to get from lenders. If you have your credit score and report, you can also use these as leverage when negotiating a rate with your lender.
If you have a bad credit history or credit score, all hope is not lost. You might still be able to make use of a cosigner to lower your interest rates. Alternatively, you can spend the next few months working really hard to improve your credit score to get better rates.
Assess your monthly budget
Your next step will be to figure out how much you can afford to pay each month. Basically, this means how big a chunk of money can you take out of your monthly cash flow (and can you afford to not pay on other things).
The average monthly car payment on a new car is $513 if you have good credit. That is no small amount. You will have to decide if you can afford to pay that amount, more or less each month.
Don’t forget to also take the additional cost that comes with a car into account such as insurance cost, maintenance cost, oil changes etc.
Assess your monthly payments
If you know how much you can afford to pay each month and you have an idea of the interest rate you can get, you can work back the numbers to see what total loan amount you can afford. You can use this handy calculator over here to do that. If you want to see how loan amounts, interest rates, and loan terms influence your monthly payments, you can also play around with this calculator over here.
Now that you know what your variables are, you can shop around for the best car deals!
How to Improve Your Chances of Getting a Car Loan
You may think you don’t stand a chance as a student. However, there are actually a few things you can do to improve it.
Here’s what you can do to improve your chances of getting a car loan:
- Save for a Down Payment
- Get a Cosigner
- Prove a Steady Income
- Improve Your Credit Score
- Improve Your Grades
- Increase the Loan Terms
These items are explained in more detail below.
Save For a Down Payment
Your chances to get a loan increase automatically as you increase the down payment amount.
Get a Co-Signer
Someone who accepts responsibility for the loan with you.
Prove a Steady Income
Lenders would like to know that you can repay the loan.
Improve Your Credit Score
Your credit score basically says whether you’ll be able to repay a loan. Improve your score by being financially responsible.
Improve Your Grades
Some lenders consider your grades before offering you a loan. Better marks lead to cheaper loan terms and conditions.
Increase the Loan Terms
Increasing the loan terms will require you to make lower monthly payments. Please note it will increase the total interest on your loan (you will have to repay more). But, a lower monthly payment may convince them to offer you the loan.
All these factors help prove to the lender that you won’t default on the loan. They will be more willing to lend to someone who can prove their ability to repay a loan.