If you are in the market for a car and beginning to investigate payment options, you may be asking yourself: are car loans open or closed? Understanding the way a car loan works is critical to making the right decision. Before you sign on the dotted line, it’s important to know what to expect. That’s why we’ve done extensive research to give you the information you need.
Car loans are closed-end loans. This means that a lender gives you a specific amount of money and expects to have both the interest and principal repaid in a set amount of time. Once you take out a car loan, you are required to make payments on a consistent schedule. And, without taking out another loan, there is no way to increase the amount of money you have borrowed.
It is totally understandable that you may want a little more information before you go out and sign up for a loan. That’s why we’ve written this post -- to help you fully comprehend how a car loan is structured.
What Is An Example of Closed End Credit?
The two most common types of closed end credit are home loans and car loans. With both types, the lender (usually a bank) agrees to give the borrower (you) a certain amount of money (the loan amount), at a certain interest rate, with a set amount of time to complete all of the payments. With a home loan or mortgage, the typical length of time is usually 15 years or 30 years. Generally, most people tend to choose a mortgage with a fixed rate of interest so they can have relative certainty regarding their payments.
Most car loans are between 5 and 6 years and feature the option, like mortgages, for fixed or adjustable rates. Like with mortgages, there are advantages and disadvantages to either approach.
Closed-end loans make things pretty straightforward. If you make your payments on time, you keep the item for which you took out the loan. If you miss too many payments and default on the loan, you will lose the car or the home for which you are using the loan.
And, unlike with an open-end loan, the amount of money you are receiving from your current closed-end loan cannot be increased as you make payments. When you get your car loan through a bank or car dealership, the amount you are borrowing is set when you sign the agreement. You cannot obtain extra money without taking out another loan.
Also, a closed-end loan can only be used for the purchase for which you are seeking the loan. In other words, you cannot attempt to take out a car loan but use the money to buy something else. Your lender is giving you the money on the condition that you will use it for the initial reason you came to them. An attempt to use a car loan for another purchase can create serious problems for you and your credit score.
So, now that we have more fully explained what a closed-end loan is and how its structure creates its limits, you probably want to know more about open-end loans so that you can be sure you fully understand the way your car loan works. The good news is that we have done the research regarding open-end loans, too. Once you read a little bit about an open-end loan and how it works, you can be confident that you’ll understand exactly how your car loan will work.
How Do Open Loans Work?
While closed-end loans limit the amount of money you can borrow over the life of the loan, open-end loans give you more flexibility. As you make payments, you can increase the amount of money to which you have access through an open-end loan.
Similarly, there is no set end date with an open loan. This means that you can take as long as you want to pay back the loan, provided that you continue to make consistent payments.
The simplest and most common example of an open-end loan is a credit card. Credit cards allow you to pay minimum amounts each month and do not demand that all of the money you borrowed is paid back by a certain date. In fact, it works to the credit card company’s benefit when you pay the loan back over an extended period of time.
Ultimately, an open-end loan allows borrowers to take as long as necessary to pay back the loan and enables them to borrow additional money over the life of the loan. These are the basic and key differences between open-end loans and closed-end loans, but they are not the only differences.
Whether you use a credit card or take out an auto loan, the key is to make consistent, timely payments. Falling behind can lead to disastrous consequences and create a lifetime of issues. Failure to pay can cost you your house or car and ruin your credit. As you are researching car loans, it is important to understand the best way to pay off your loan.
Is It Better to Pay Principal or Interest on a Car Credit?
Because car loans are closed-end, the sooner you can pay them off, the better. That’s why, when dealing with a closed-end loan, it’s always best to pay the principal (the amount you borrowed) rather than just the interest.
When you take out a loan, it is structured so that you focus on paying the interest first. This means that you can go months or years making payments on time and not make a dent in the actual loan amount itself. When you pay only the amount due, you are paying towards the interest only. This means that you are costing yourself money in the long run.
The simplest way to quickly pay off your loan is to pay more than the amount due each month. However, not all lenders allow this. You will need to be sure that you can work out this type of payment structure with them in advance. You cannot assume that the extra payment amount will automatically be credited to your principal.
Whenever possible, though, you should always attempt to focus on the principal rather than the interest. This is especially true for a closed-end car loan. After all, the sooner you finish making the payments, the sooner you are the sole owner of the vehicle.
Be Sure to Consider All of Your Options When Purchasing A Car
As you prepare to purchase a vehicle, make sure that you have considered all of your options. Financing your car through a closed-end loan can be a great solution. Just be sure that you understand the terms and conditions of the loan, and remember that you can use the information from this post to make an informed decision.