Types of Car Loans to Avoid and Alternatives to Consider

If you're in the market for a new car, you're likely to come across a variety of car loan options. However, some types of car loans are better left avoided.

One type of car loan to avoid is the balloon payment loan. This loan type requires you to make regular payments, but at the end of the loan term, you'll still owe a large lump sum, known as a balloon payment.

The balloon payment can be a significant financial burden, and it's not uncommon for borrowers to struggle to make this final payment. In fact, a study found that 1 in 5 borrowers with balloon payment loans end up defaulting on the loan.

Another type of car loan to avoid is the title loan. These loans are secured by the vehicle's title, but they often come with exorbitant interest rates and fees. In some cases, the interest rate can be as high as 300% APR.

Predatory car loans are structured to take advantage of unsuspecting buyers. They can be disguised as good loans, but are actually designed to trap you into a bad deal.

Some predatory car loans are predatory by default, structured to appeal to those who are unfamiliar with good loans or who can't qualify for a car loan. This often includes those with low income.

Predatory lenders will try to rush you through the paperwork, making it difficult for you to read and understand the loan terms. This is a tactic to prevent you from noticing the nasty details that make the loan predatory.

Finance companies are required by the Federal Truth in Lending Act (TILA) to provide a disclosure that outlines certain information about your loan, such as its APR and fees. However, if you're being offered a predatory car loan, the lender may try to rush you through the paperwork to prevent you from reading and understanding the disclosure.

High APRs and fees can sneak up on you.

Your loan's APR, or annual percentage rate, is a calculation made up of your loan's principal, interest rate, fees, taxes, and additional options.

Predatory lenders may inflate a loan's interest rate, typically by 2.84% to 5.04%.

In a normal car loan, origination fees typically make up 0% to 2% of the total loan amount, plus any associated service or documentation fees.

Predatory lenders may also inflate your fees or add hidden charges, such as a fee for having bad or little credit or a flat fee for every $X you borrow.

The APR of some predatory car loans, particularly payday loans, may even stretch high into the triple digits, with nearly 400% APR.

You may end up with much higher interest rates and APR than expected.

If you have a poor credit score, you'll likely need to obtain an auto loan specifically designed for people with bad credit.

For instance, uncommonly short repayment terms and interest rates over 10% on an auto loan can be a warning sign of predatory lending.

You'll often be rushed through the paperwork, but don't let that happen. The Federal Truth in Lending Act (TILA) requires finance companies to provide you with a disclosure that outlines certain types of information about your loan.

The TILA disclosure informs you about potentially costly aspects of your loan, such as prepayment penalties. This is crucial information that can save you from a bad decision.

The lender may try to rush you through signing, but take your time to read and think about the terms of your loan.

The pressure to sign paperwork can be intense, but it's essential to slow down and read the fine print. The Federal Truth in Lending Act (TILA) requires finance companies to provide you with a disclosure that outlines certain types of information about your loan.

This disclosure should include your APR and fees, as well as any potentially costly aspects of your loan, such as prepayment penalties. The lender might try to rush you through the signing process to avoid you noticing these details.

By rushing through the paperwork, you could end up with a loan that's predatory and a bad decision. It's crucial to take the time to read and think about what's in the loan before signing.

Financing Without Shopping Around can lead to a bad deal. You trust your bank with your checking account and IRA, but that doesn't mean they'll give you the best car loan rate.

A quick online check of rates in your area may show a range from 1.99 percent to 7 percent or more. This means your bank might not even match the average APR.

Don't assume your bank will give you the best deal, or even a good one. They may have a high annual percentage rate (APR) that can cost you a lot of money over time.

Shopping around for a car loan can save you thousands of dollars in interest payments.

Negative Amortization is a sneaky trap that can leave you owing more than your car is worth. Some predatory loans promise seductively small monthly payments, but what's not discussed is how these loans lead to negative amortization.

With a negative amortization loan, your monthly payments are too small to pay off the accumulated interest. As a result, the unpaid interest is tacked onto your loan, causing you to owe more than before you made your most recent payment.

This can be a recipe for disaster, especially when combined with depreciation. If you're left with a significantly underwater car loan, you may be stuck owing more than your car is worth.

To calculate negative equity, subtract the value of your car from what you owe. For example, if you owe $17,000 and your car's value is $11,000, you have negative equity of $6,000.

Rolling negative equity into a new loan by trading in a car can make things even worse. The dealer will credit you for the trade-in, but add the remaining negative equity to the new loan, leaving you owing more than the new car is worth.

Predatory lending practices aren't the only way for a shady finance company to take advantage of you. Some types of car loans are predatory by default, structured to appeal to those unfamiliar with good loans or those who can't otherwise qualify for a car loan.

Avoiding a bad loan is all the more important if you're already working hard to make ends meet and improve your financial wellbeing. No matter how desperate you are for a new car loan, make sure you exhaust as many alternative options available to you before taking out a potentially predatory loan.

Credit unions are a great alternative to predatory lending. They offer lower rates than banks and a more forgiving attitude toward short or spotty credit histories. You can expect a credit union car loan to be a better deal than a loan from a bank.

To get a credit union car loan, you'll need to become a member first. Most credit unions allow you to qualify for membership based on the city where you live or work, the company you work for, or an organization you belong to.

Financing a car with a bad-credit car loan from the dealer can be a costly mistake, with average interest rates as high as 11 percent in 2015, according to Interest.com.

A bad credit score, like roadkill, can make it hard to get a good loan, and dealers may take advantage of that. They might offer you a high-interest loan, or even try to repossess your car.

Some shady dealers will push you into a loan you can't afford, and plan to repossess your car.

You may have found yourself in an upside-down car loan situation, where the loan balance exceeds the car's value. The good news is that unless you've totaled the car in a wreck or you have to sell in a hurry, there are ways to get out of a car loan.

Refinancing can be a viable option. If interest rates are lower than what they were when you took out the original loan, refinancing allows you to pay off the car faster, or at least get some equity. Large lenders usually aren’t interested, but a community bank or credit union may consider the option.

It's possible to transfer the balance of your car loan to a credit card with a 0% introductory offer. At the end of the introductory period – 12-18 months on most cards – refinance the remaining balance at a credit union or peer-to-peer lender.

A voluntary surrender of your car is another way to get out of a loan. This allows you to give the collateral – your car – back to the lender and wash your hands of the whole thing. A voluntary surrender doesn’t impact your credit as much as a repossession and may also spare you from paying penalties and fees typically associated with a repo, saving you some money in an already stressful situation.

Packing can be a sneaky way to inflate the total cost of a loan. Loan packing is an illegal predatory lending practice that involves adding optional add-ons to your loan without your knowledge or consent.

These add-ons can include things like extended warranties, maintenance plans, or other services that you may not need. What matters is that you're being charged for them, which can increase your APR and the overall cost of the loan.

If you're not careful, you might end up paying more for a loan than you initially agreed to. Loan packing is a serious issue that can have serious consequences for your finances.

Subprime auto loans can be a high-risk option for borrowers with bad credit. These loans often come with high interest rates, typically above 11 percent, and can result in thousands of dollars in interest payments over the life of the loan.

A borrower with a credit score below 640 is considered subprime and may be offered a subprime auto loan. The average interest rate for a deep-subprime borrower, with a credit score under 500, is around 14.5 percent.

Borrowers should be aware that subprime loans can become predatory if the lender takes advantage of the borrower's financial situation. This can happen if the interest rates, penalties, and fees exceed what's reasonable for the borrower's circumstances.

If you're considering a subprime auto loan, be prepared to pay extra fees beyond what's typically included in a standard loan. Prepayment penalties and high interest rates are common features of these loans.

Having no credit check may seem like a dream come true, but it can quickly turn into a nightmare. Unfortunately, bad loans taken out without a credit check may not be reported on your credit report, so paying them on time won't necessarily improve your credit.

You may be asked to provide cash upfront beyond the down payment, or jump through hoops not typical of the borrowing process. This is because the lender has no idea about your creditworthiness, so they may inflate your interest rate to offset the risk you pose to them.

Car loans are amortized, which means one portion of your monthly loan payment goes toward the loan's interest, and another portion goes toward the principal.

Getting upside down on a car loan can happen in many ways. Inadequate research can lead to buying a car with a higher price than similar models, making you upside down from the start. For example, if you buy a car with a sticker price of $30,000 and similar models are selling for $27,500, you're already upside down.

Cars depreciate quickly, losing 20% of their value immediately and 50% of their value by the third year. This means that the less money down you put, the more upside down you'll be. No-money-down loans can lead to this situation, making it difficult to pay off the loan.

Long-term loans with terms of 72 or 84 months may seem manageable, but they can't keep pace with depreciation. You'll be paying for a car that's five or more years old, making it impossible to get out of the loan. This can lead to negative amortization, where your monthly payments are too small to pay off the accumulated interest.

Here are some common ways to get upside down on a car loan:

Rolling over negative equity into a new loan can also lead to getting upside down. This means adding the remaining balance of the old loan to the new loan, making you owe more than the new car is worth. For example, if you still owe $7,000 on a car that's worth $5,000, the dealer will credit you $5,000 for the trade-in and add the remaining $2,000 to the new loan.

Subprime auto loans can be a necessary evil for those with poor credit, but it's essential to understand the risks involved. Borrowers with bad credit typically have credit scores below 640, which can make them a high-risk to lenders.

High interest rates are a common feature of subprime auto loans, with rates often exceeding 11% on average, according to Interest.com. This can lead to a significant amount of interest paid over the life of the loan.

Subprime car loans aren't inherently predatory, but they can become so if the terms are unfair or the lender takes advantage of the borrower's financial situation. A good rule of thumb is to compare loan offers and ensure the interest rate and fees are reasonable.

Some subprime auto loans may include prepayment penalties, which can make it difficult to pay off the loan early. This can lead to a cycle of debt that's hard to escape.

If you're considering a subprime auto loan, make sure to research the lender and read the fine print. A little caution and due diligence can go a long way in avoiding a predatory loan.

Here are some common features of subprime auto loans:

Keep in mind that some subprime auto loans may be more predatory than others, so it's essential to be aware of the risks and take steps to protect yourself.