Car loans 101: Understanding your car loan contract

Buying a car is no less than achieving a milestone for every Filippino. Whether you are a college student, a family man with two kids and a 9-to-5 job, or a high-profile businessman, having a car by your side will be very helpful and improve your quality of life.

Not everyone has the leisure to buy a car in cash (plus, it has its own set of pros and cons), so car financing is available. This option makes car ownership manageable for many people who otherwise won’t be able to fulfill their dreams. However, car financing has its ups and downs, which we have discussed in detail here.

If you have decided to finance your car purchase, you have several options, including banks, credit unions, car dealerships, and friends and family. No matter which car loan institution you choose, one thing that will remain common is the Car Loan agreement.

In this article, we’ll discuss the car loan agreement in detail and provide a comprehensive guide on its meaning, importance, parties involved terms and conditions, and other important information an applicant must know and consider before signing.

Understanding a car loan agreement

What is a car loan agreement? It is a contract between the lender and the borrower. It outlines essential terms and conditions of a loan, like a loan amount, interest rate, collateral (if any), and repayment schedule. Overall, it documents the rights and obligations of both the parties, borrower and lender.

Importance of car loan agreement

A car loan agreement plays a crucial role in the borrowing process for not one but several reasons, including -

Legal protection - If properly drafted, a loan agreement offers legal protection to both the lender and borrower. How? By clearly defining the rights, responsibilities, and obligations. In case of a dispute, it serves as evidence for the agreed-upon terms. Transparency and clarity - The loan agreement ensures clarity and offers full transparency to both parties, thus reducing the chances of misunderstandings or disputes arising during the loan or claim process. Enforcement of obligations - If necessary, the loan contract can be used to enforce the terms and conditions of the agreement through legal channels, ensuring that both parties fulfill their respective obligations and commitments.

Parties involved in a car loan agreement

Usually, a car loan agreement involves two primary parties, including - the borrower and the lender.

Lender - It concerns an individual or a financial institution offering the loan amount to the borrower. They often have certain eligibility criteria for the borrowers and assess their creditworthiness before giving out the loan. Borrower - A borrower is on the receiving end of the agreement, the one who will get the loan funds from the lender. He/she is under the obligation to repay the borrowed amount along with the interest within a specified period.

Key elements to evaluate in a car loan agreement

While the specifics of a car loan contract differ as per the lenders and their policies, a few elements are universal and are found in all car loan contracts. It becomes essential for a borrower to go through each of them thoroughly to get a clear idea of what he/she is signing up for.

Without any delay, let’s get to car loan terms you must know about -

Interest rate & Annual percentage rate (APR)

One of the most crucial things to look into in a car loan contract is the interest rate charged by the lender. In the Philippines, two types of interest are charged when it comes to car loans, fixed rate, and variable; we have discussed it in detail here. Out of the two, the former is most commonly used and is preferred by borrowers who like stability and are interested in long-term planning.

As for the Annual Percentage Rate (APR), it refers to the total annual cost of borrowing from a lender. In simple terms, APR = Interest rate + any additional fees charged by the lender (service fees and processing fees).

The APR is a crucial figure that borrowers must consider when comparing loans from different lenders. For example, a car loan offered at a low interest rate but with high hidden charges can cost more in the long run. Therefore, always take note of the APR.

Loan tenure

When evaluating your car loan agreement, check the mentioned repayment period, aka, loan term. In the Philippines, car loan periods typically range from 12 to 60 months. However, lenders are offering longer loan terms as well.

The car loan term length can be short or long, each with its outcome. The table below explains them easily.

Shorter loan term	Longer loan term
Higher monthly payment	Lower monthly payment
Lower overall interest costs	Higher total interest costs
Manageable, but requires high availability of funds that too quicker	More manageable, as fund requirement is divided over a period of time

While the longer loan term with lower monthly payments might attract you at first, do not forget to analyze the overall cost of the loan. However, if you are thinking of opting for a shorter loan term, make sure the monthly payments align well with your monthly budget and overall financial goals.

Downpayment

In the Philippines, most car loan lenders require a minimum downpayment of 20 to 30% of the car’s cost. While a larger down payment sum will hurt at first and might require some planning, it will reduce your loan amount, which in turn will lower the interest and monthly payments made over the term of the loan.

Before moving forward with the loan agreement, talk with your lender about the downpayment requirements and assess how the sum fits into your overall budget.

Additional fees & costs

A car loan is not just limited to the principal amount and interest rate, but it often includes additional costs and some hidden fees, which increase the overall cost of the loan. Here are some common fees to look out for in a car loan contract -

• Processing fees
• Prepayment penalty
• Late payment fees
• Chattel mortgage fee

Note: These additional fees and costs on a car loan vary significantly between lenders, and therefore, it is important to ask for a detailed breakdown. Also, it’s better to enter a loan agreement prepared for these costs rather than getting them as a surprise later.

Loan payment flexibility

Often, lenders offer adjustable or customizable payment schedules as per borrower’s cash flow or salary schedule. Thus helping them manage the monthly budget with ease.

Further, a borrower must inquire about prepayment penalties, if yes, then by paying the loan early, they can save money on interest in the long run. Also, ask the lender about loan restructuring or refinancing options. It is a pretty useful tool in times of unexpected financial challenges.

Insurance requirements

Car loan contracts usually require the applicant to have a comprehensive car insurance plan along with the mandatory CTPL insurance. Why so? Well, comprehensive insurance offers financial protection to the car owner and the car with the following damages/dangers - car theft & burglary, acts of god, fire & explosion, riots, strikes, liabilities caused by accidental collision & overturning, damage to your car, etc.

It is better to clarify with the lender beforehand if the insurance costs are part of the monthly payment or are billed separately. A few lenders in the Philippines offer bundled packages, while this will make things easier, it is essential to compare coverage and premiums to make sure you get the best deal.

Total loan cost & monthly payment analysis

Always have a closer look at the total loan cost before signing the contract. Further, get a clear understanding of the monthly payment, i.e., understand how much of each installment goes towards the principal vs interest and other fees.

Review loan terms

Before signing a loan agreement, it is essential to carefully review the loan terms to make sure they align well with your finances.

Practices a borrower must follow

• Do thorough research - Compare interest rates and loan terms from multiple lenders. So, make sure there is adherence to fair practice by the lender.
• Document all transactions - This practice will come in handy when a dispute arises between the lender and borrower. Proper documentation of all the documents, digital proof of transactions, and receipts will prove useful in case the dispute escalates and there is a legal inquiry.
• Be open to communication - In case of confusion, question, or trouble, it is advisable to have open communication with the lender. A face-to-face meeting to explore the option of loan refinancing/restructuring or ask for a grace period in case of difficulty in making periodic payments.

Bottom line

To secure a car loan, a Filipino is required to undergo a thorough investigation and careful consideration. A loan agreement is one such vital tool in a borrower’s journey, offering clarity, safeguarding them from disobedience, and providing enforceability. It is, therefore essential to have a clear idea of the terms of the loan agreement before going forward with the signing ceremony. So, take your time to thoroughly review and comprehend every clause of the contract and empower yourself with the knowledge that makes you a confident borrower.

Also Read: Should you finance a car? Weighing the pros and cons