Why Interest Is Almost Always Charged on Car Loans

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The most inexpensive way to buy a car is to use money from your personal savings. However, cash may not always be readily available to you when you want to purchase a new or used car. For this reason, you may need to borrow some money so you can buy the car you want. Commercial banks, building societies, finance companies, credit unions and dealerships are all common options for individuals seeking financing to buy a car. All these financiers almost always charge interest on the loans that they provide. The interest is charged as a percentage of the principal amount loaned out and must be paid back in addition to the full principal amount. Interest rates may be presented as a monthly, bi-annual or annual rate, depending on the financier's specific lending policies.

A common question many people usually ask is: why is interest almost always charged on car loans? Read on below to understand why.

To cover administrative costs

There are people and systems involved in the processing of car loans from start to finish. There is checking of the applicant's credit rating and plenty of paperwork to deal with when processing the loan. Hence, lenders usually hire administrative staff to provide individuals seeking car loans with the assistance they need. The administrative costs incurred when processing loans are usually included in the interest charged to borrowers.

To cover losses from defaulters

Every financier faces default risk. Default risk refers to the likelihood that an individual who has been provided with a loan facility will fail to make the agreed payment in a timely manner. The interest charged on car loans is usually meant to help offset the losses that may be suffered by the lender in the event that they fail to pay up in good time. To cushion against the risk of default, lenders usually check the credit rating of each applicant. People with poor credit scores may generally not qualify for car loans because they are considered to have a high default risk.

To earn a profit

Like many other kinds of businesses, institutions that provide car loans want to make profit. Charging interest on car loans provides a perfect avenue for them to make profit. When lenders prepare their end-of-the-year financial statements, part of the profits that they record is usually realised from the interest paid by borrowers.

If you need a loan to buy a car, weigh up the various advantages and disadvantages of each financing option available to you, and choose the option that best suits you for your car loan.