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What Determines Car Loan Interest Rate?

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Ever wondered why there are different car loan interest rates? Why some people get better rates than others? Rates differ for several reasons, and listed below are some of the reasons why interest is not constant.

Credit score

If you will buy a car soon or plan to do so in the future, you better work on your credit situation and improve your score, as this is a key determinant of your car loan interest rate. The three-digit number represents your creditworthiness—the higher your score, the more creditworthy you are.

Lenders offer lower interest rates to those with higher scores because they present less credit risk. As implied by the scores they have, borrowers with high credit scores are more likely to repay the debt and do it on time. If your score is low or average, take time to raise it before car shopping to qualify for better rates.

Lender

The source of auto financing is another important factor that affects car loan interest rate. Some lenders, like banks and dealerships, may charge higher interest because they earn profits from auto loans. Because credit unions are non-profit, they can offer lower rates. Meanwhile, online lending companies can offer low interest, not just because of tight competition, but also because they have less overhead costs.

Thus, you can increase your chances of getting a good rate by choosing the right lender. Do some research and submit several loan applications to different lenders to see what rates you will get. You can only get the best rate when you do comparison shopping.

Loan term

The length of the repayment period also influences car loan interest. If you want to pay a lower rate, choose a shorter term (like 36-month or 48-month period). The rate is lower for short terms because there is less risk for the lender since the loan will be repaid sooner.

Opting for a shorter loan term results in you having to pay a higher monthly payment. However, your overall loan cost will be lower because you will not be charged high interest. It is therefore not a good idea to extend your term unless absolutely necessary.

Down payment

The amount of money you will pay upfront for the auto purchase also determines whether you will get a high or low interest rate. This is the rule: the higher the down payment, the lower the rate. Lenders offer lower rates to car buyers who put down more money because the latter prove themselves serious about the purchase. The fact that they invested a significant sum upfront tells lenders that they are less likely to default their payments, making them less of a risk.

The recommended amount for a car down payment is 20 percent of the car’s purchase price. Nonetheless, if you can pay more, you should do it. You will save more money in the long run by borrowing less for the auto purchase.

Trade-in/cash equity

This car loan interest rate determinant works almost the same way as the down payment. If you will trade in your current car to purchase another one, its value can help reduce the rate you will get—as long as you have positive equity.

Car choice

Believe it or not, the car you choose to buy also affects the rate you will get. Used cars may be cheaper than new ones, but they usually come with higher interest. The reason behind this is that the resale values of pre-owned vehicles are more difficult to predict. Lenders raise interest to protect themselves from potential losses.

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