One of the most important factors to consider when purchasing a car is the interest rate on your car loan. The interest rate is the percentage of the loan amount that you pay to the lender each year. The higher the interest rate, the more you'll pay in total for your car.
Understanding car loan interest rates can help you save money in the long run. By shopping around for the best interest rate and making a large down payment, you can lower your monthly payments and pay off your loan faster.
The Basics of Car Loan Interest Rates
Remember: the interest rate is the percentage of the loan amount that you pay to the lender each year.
For example, if you have a $20,000 car loan with an interest rate of 5%, you'll pay $1,000 in interest each year (as long as you make your payments and no other terms apply).
Interest rates differ the from annual percentage rate (APR) however and it's important to know the difference. APR is a more comprehensive measure of the cost of borrowing money. APR includes the interest rate and other fees associated with the loan, such as origination fees and closing costs.
For example, for that same $20,000 car loan at a 5% interest rate and an APR of 6%, you'll pay $1,200 in interest each year.
The interest rate on your car loan, and most other loans, is determined by several factors, including your credit score, the length of your loan, and the type of car you're financing.
- Credit score: Lenders use your credit score to assess your risk as a borrower. A higher credit score generally means a lower interest rate.
- Loan term: The longer the loan term, the higher the interest rate will be. This is because the lender is taking on more risk by lending you money for a longer period.
- Type of car: The type of car you're financing can also affect the interest rate. Luxury cars and sports cars tend to have higher interest rates than economy cars.
Factors that Affect Car Loan Interest Rates
In addition to the factors mentioned above, there are a few other things that can affect your car loan interest rate.Â
- Down payment: The more money you put down, the lower your interest rate will be. This is because the lender is taking on less risk when you have a larger down payment.
- Prepayment penalties: Some lenders charge a penalty if you pay off your loan early. If you're planning on paying off your loan early, make sure to factor in the prepayment penalty when comparing interest rates.
- Loan origination fees: Some lenders charge a fee to process your loan application. This fee can add to the overall cost of your loan, so be sure to ask about it before you sign any paperwork.
Of course credit score is a big factor that plays into how high, or low, the interest rate may be. Here are some basic tips to start improving your score before you take out a loan: pay your bills in full and on time, ask for credit limit increases to lower your credit utilization rate (keep it around 30% or less), make sure to dispute any wrong information that shows up on your credit report, and eliminate any bad debt like credit cards if you can.Â
