Frequently Asked Car Loan Questions
Milburn Auto Sales, Guelph
What you should know about financing a vehicle with a credit line
FLUCTUATING INTEREST RATES
The interest on a credit line is a "variable" (floating) rate. This means that when the prime rate changes, so does the interest charged on your credit line. You have no protection from increasing interest rates. The advantage of financing with a "fixed" interest rate from the dealership's Dealer Plan is that the interest rate is "locked in". This protects you from climbing interest rates. In the event that you finance with the Dealer Plan when interest rates are high, you would have the option of using your credit line to pay out your Dealer Plan loan if the rates began to dramatically decrease. This is made possible by the fact your Dealer Plan loan is an open agreement that can be paid into or paid off at anytime without monetary penalties.
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SPECIAL NOTE: Many people are attracted to credit lines because of their low interest rates. Rates on an unsecured (no collateral) credit line can be as low as one or two points over the prime rate. However, credit line interest rates can be substantially increased by the branch. If, for example, you were slow repaying your monthly credit line obligation for 2 or 3 months (because of some unforeseen difficult circumstances), your credit line interest rate could be more than DOUBLED! Credit line rates can increases even if the prime rate doesn't!
FURTHERMORE: In many cases, Dealer Plan "fixed" interest rates will be less than 2 percentage points higher than credit lines. With the "fixed rate" you always know what your interest rate will be, how much your payment will be, and exactly when it will be paid off!
If you have an outstanding balance of $30,000 on your credit line because you have used it to pay for your vehicle, this means that your monthly payment would be 3% of $30,000, which equals $900 a month. This is much more than what a monthly payment would be over a normal 60 month term on a Dealer Plan Loan (approximately $600).
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You may also be given the option of making "interest-only" payments. In this case, you are only paying the interest charge for a single month and not paying down the principal amount of the outstanding balance. Although this may seem convenient and affordable, for many people this becomes a TRAP where they become comfortable paying the lower amount each month, yet never pay down the balance.
Many credit lines for businesses have fees such as a $15 per month usage fee and a charge to certify cheques (even "secured" credit lines). Even if you are able to obtain a very low "variable" interest rate with your credit line, these extra charges end up costing you more per month than a higher "fixed" interest rate through the Dealerships Dealer Plan.
POOR DISABILITY CREDIT PROTECTION COVERAGE
Disability insurance on a credit line does not usually cover the entire payment; rather it covers the payment on the "average balance" over the previous twelve month period. You may be in a situation where you are unable to cover the minimum required payment on your "current" balance even if you have the disability coverage.
Unlike Dealer Plan disability insurance, credit line coverage often requires the completion of a medical questionnaire at time of credit line application to qualify for the coverage. You can even be denied coverage based on your answers to the questionnaire. Further, disability coverage on credit lines are referred to as "elimination" policies. This means that there is normally a "wait period"; a period of time where no benefits are paid. Ninety day wait periods are common with credit lines. Credit lines coverage may have other restrictions before benefits are paid.
Disability insurance on a Dealer Plan loan makes your loan/lease payments in the event that you are ill or injured and cannot work at your job and chosen profession. There are no medical questionnaires, blood or urine tests or physical examinations required for acceptance into the program and all customers are accepted into the program regardless of occupation and current health. All customers in the insurable age group (e.g. ages 18-65) also pay the same premiums. There are no limits to the number of claims during the life of the loan/lease agreement, confinement to the home or hospital is not required for payment of benefits, the coverage pays in addition to any other insurance benefits or salary continuations being received and there is no income tax payable on the benefits. You can even choose various "retroactive" plans that pay benefits from the first of the recorded illness or injury.
A credit line is like a credit card in that it can be utilized on an on-going basis. This is referred to as "revulving credit". The "trap" that many credit line customers fall into is that they never pay off their vehicle or they pay if off very slowly over a long period of time. Many also pay off "some" of the balance and then run it up again with other purchases. The interest charges become extremely expensive when they are tacked onto large dollar balances over long periods of time.
Dealer Plan loads are referred to as "installment credit". You make equal monthly payments based on the initial amount financed over a chosen "fixed" term (e.g. 60 months).
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There is no guaranteed re payment term attached to a credit line (e.g. like a 58 or 60 month term on a conventional loan). Since the term is not guaranteed by the financial institution, this means that the line can be "called" at any time. If the financial institutions has concerns about your ability to repay the balance owing on your line (because of an economic recession, a downturn in your career field, job loss, etc.) they can demand FULL repayment of the balance owning on thirty days notice. The financial institution may also become nervous about your ability to repay when your credit line is constantly at its maximum and you are making interest-only payments. In some cases the financial institution may force you to close your credit line and re-finance the balance on a high interest consolidation loan. In this situation, not only do suffer the high interest rate, but your credit rating is damaged as well. The credit line is reviewed each year by the financial institution to decide whether or not to allow it to continue.
POOR UTILIZATION OF A CREDIT LINE
Credit lines are offered to people like you that have established an excellent credit rating, a good relationship with your bank, career stability, residence stability and success. Credit lines are a "privilege"; the unmonitored use of the banks money for your own purposes. Personal credit lines were truly designed for things such as:
- Home additions, improvements or remodeling
- Home Landscaping or a Pool
- Home theatre
- A vacation
- A child's university fund
- A child's wedding
- Debt consolidation
- Cash for an investment opportunity
Why waste the privilege of your credit line on a vehicle, when low, "fixed" rate interest financing is so easily available through your dealer. Have your new vehicle financed by a Dealer Plan loan and still have your credit line untouched and completely available for whatever you want!
What you should know about paying cash for vehicle
MAY BE PENALTIES FOR CASHING OUT INVESTMENTS (E.G. MUTUAL FUNDS)
Many mutual funds sold ten or twenty years ago have significant monetary penalties if they are cashed out before their maturity. You may wish to leave your investment in tact and finance instead.
LOSS OF EMERGENCY FUNDS
You are depleting a large sum of money from your savings or investments when they pay cash for a vehicle. This money could be needed for emergencies later. e.g.:
- A major home repair
- A loan to a family member needing money
- A trip due to a family emergency
- A disability where saving are needed to replace income from work
- Special medical bills, medication and treatments
- A funeral
LOST OPPORTUNITY FOR INEXPENSIVE LIFE AND DISABILITY LOAN INSURANCE
In the event that you become disabled and unable to work, you may have little money to draw upon from savings for income if you have paid cash for you vehicle. By financing the vehicle and insuring the loan with credit life and disability insurance, you can leave your cash in saving or investments. In the event that you were unable to work, you would have your saving or investments in tact and be paying for the vehicle with insurance benefits instead of your savings.
If you are over fifty years of age, you have the added benefit of being able to qualify for very inexpensive credit life and disability insurance premiums. This is due to the fact that the insurance is an "average premium", which means that all customers that qualify (generally between the ages of 18 and 65) pay the same premium. Customers over fifty would normally pay much more money for insurance than a younger person if it was purchased directly from an insurance company.
LOSS OF INVESTMENT OPPORTUNITIES
Paying cash for a vehicle depletes money from your saving. This limits your investment opportunities. At some time in the future if your still have your savings, they could be used for:
A down payment for a real estate purchase such as an investment property, cottage or a larger home
Home renovations or a pool
Registered retirement savings plan (R.R.S.P.) Canada Savings Bonds, Guaranteed Investment Certificates (G.I.C.'s) mutual funds, stocks
LOST OPPORTUNITY TO "PAY DOWN" MORTAGE
Most mortgages allow you to pay off up to 15% of the principal amount borrowed each year without a penalty. By paying down your mortgage instead of paying cash for your vehicle, this significantly reduces the interest charges and the amortization of your mortgages. The savings more than offsets the cost of interest on a vehicles loan.
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NO CREDIT RATING ESTABLISHED
When you pay cash, there is no establishment of a positive credit rating. A positive credit rating is essential for borrowing money from financial institutions for things such as mortgages, lines of credit, home improvement loans, credit cards, ect. Financing through your dealer plan establishes your credit rating