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PHASE THREE: “I’m buying a ride.”

Nothing quite compares to the feeling of purchasing your first car! But don’t let the freedom of the open road distract you from your new responsibilities as a car owner. Below, you’ll find details to help you manage your loan, pay off your car, and insure it.

1) Title and Payday Loans

A title loan offers you cash from the lender, and in return you sign over the title of your paid-for car to secure the loan. If you decide to take out a title loan, tell the lender you are in the military, and they must cap your interest rate at 36% (based on a law passed in 2006 and effective in 2007). Typically, these loans are due back in full 30 days later.

  • What’s good about Title Loans: There's no credit check and only minimal income verification.
  • What to look out for:
    • High interest rates: Car title lenders are in a different category than credit card companies or banks and work around usury laws. Thus, title loan lenders are able to charge triple digit annual percentage rates (APRs).
    • Fees: In addition to high interest, these car title loans usually include a number of fees that add up quickly. These include processing fees, document fees, late fees, origination fees and lien fees.
    • Balloon payments: Lenders also give borrowers the option of interest-only payments for a set period of time. In these cases, the loans are usually set up for a longer period of time (compared to the typical 30 days) and the borrower can pay the interest only on the loan. These types of payments are called "balloon payments" where the borrower pays the interest of the loan each month and at the end of the term they still owe the full amount of the loan.
    • Your lender keeps a key: Many who receive title loans must surrender a copy of their car key to the lender. In one state, the lender installs a GPS device in the car. If you can't pay, they will come looking for you and your car.

Payday loans are unsecured loans and carry similar terms and interest rates as title loans. Be very careful before entering into these types of loans.

2) Car Loans

Getting a loan for a car usually involves a financial institution such as a bank or credit union or choosing to use the dealer’s financing options. (The ideal way to purchase a car is using your savings, but most people don’t have sufficient funds in their personal savings to do this.)

Three things you should do when choosing to finance a car:

  1. Get a copy of your credit report before you start shopping for a car and clean up any negatives on the report. Your credit history and credit score will factor heavily in what interest rate you will be charged—the higher the credit score, the lower the interest rate.
  2. Determine how much you can afford to spend on the car—especially the monthly payments, to include the insurance—and target that amount when you shop for a vehicle. Keep your figures honest and only buy what you can afford to buy—this will help you from getting upside down in your loan.
  3. Compare your financing options, and look for a low interest rate loan. Obtaining a loan from a credit union can be easier than obtaining one through a bank, and is usually better than dealer financing.

When you shop for car insurance, make sure your coverage is what you need for the loan and for your driving habits. And make sure your loan is flexible to allow for prepayment (paying the loan off early) without penalty.

3) APR vs. APY

APR stands for Annual Percentage Rate. APY stands for Annual Percentage Yield. The Difference: APY takes into account compounding interest whereas APR does not. This means, when figuring out how much your car payments will amount to over time, you must be prepared to do the math!

What is compounding interest?

It’s interest earned on principal interest. For example:

A credit card company might charge 1% interest each month. The APR would equal 12% (1% x 12 months = 12%). This differs from APY, which takes into account compound interest. The APY for a 1% rate of interest compounded monthly would be 12.68% [(1 + 0.01)^12 – 1= 12.68%] a year.

If you only carry a balance on your credit card for one month's period you will be charged the equivalent yearly rate of 12%. However, if you carry that balance for the year, your effective interest rate becomes 12.68% as a result of compounding each month.

4) Negative Equity or Rolling the Loan

When the value of your car falls below the outstanding balance on the loan used to purchase that asset, you experience negative equity. Negative equity is calculated simply by taking the value of the asset less the balance on the outstanding loan. In short, negative equity means that you’re paying more money for less of your vehicle!

Buyers Beware.

When talking about a car loan, you may be able to trade in the car for another one, but the negative equity may be rolled into the new loan, increasing your payments and decreasing your actual ownership of the vehicle. This is not considered a good financial decision, and should be avoided. Consider paying down the loan more before buying another vehicle, or consider selling the vehicle privately and not trading it in.

5) Auto Insurance

Auto insurance protects you against financial loss if you have an accident. It is a contract between you, the insured and the insurance company. You agree to pay the premium and the insurance company agrees to pay losses as defined in the policy. If you're financing a car, the lender may also have requirements. Most auto policies are for six months to a year. The insurance company should notify you by mail when it’s time to renew the policy and to pay the premium.

Auto Insurance provides property, liability and medical coverage.

  1. Property coverage pays for damage to or theft of the car.
  2. Liability coverage pays for the legal responsibility to others for bodily injury or property damage.
  3. Medical coverage pays for the cost of treating injuries, rehabilitation and, sometimes, lost wages and funeral expenses.

Know your Auto Insurance vocabulary:

  • Liability coverage: This covers injuries or damages a policyholder may cause during an auto accident (bodily injury and property damage).
  • Medical coverage: This pays for the medical expenses suffered by you and your passengers after an accident. You're also covered if you're driving someone else's car (with their permission) or from injuries suffered if a car hits you—no matter who caused the accident.
  • Personal Injury Protection: This pays for medical expenses and lost wages for you and your passengers who are injured in an accident. It also covers funeral costs.
  • Uninsured/underinsured motorist: This covers incidents when a policyholder is involved in an accident caused by a driver without any insurance policy or has insufficient insurance policy.
  • Collision coverage: This covers the repairs of the policyholder’s car when the damage to the car is due to colliding with another car or hitting another object like a fence, a wall or a tree.
  • Comprehensive coverage: This pays for damages on the policyholder’s car caused by other reasons (excepting collisions such as fire, hail and flood).

Other additions to your insurance policy may include towing, rental car reimbursement, and gap coverage should your car be totaled in an accident and you owe more than the book value.

Go to Phase Four

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