7 factors that determine your car loan interest rate

Posted on Friday, December 9, 2016 - 11:29

With all the paperwork and bureaucratic process that you have to go through, buying a car can feel like an arduous prospect. Besides the price tag, after purchasing said car, there are various other stressful decisions that you have to make that, if not done in a responsible, proper fashion, can affect your financial well-being in the long term. One of them is taking loans on cars.

If you are pondering on taking a loan to purchase your car, the most important thing to do is inform yourself on how lenders determine your car loan interest.

Some of the important factors are your credit score, the amount of money borrowed, the down payment and debt to income ratio.

Without further ado, here are the most important seven factors that determine your car loan interest rate.

1. Age of vehicle

As a general rule, loans given for older, second or third-hand cars come with a higher interest rate than in the case of new vehicles. At first glance, this might look a bit illogical, but you have to take into consideration the fact that old cars, due to their age and usage, are constantly depreciating.

So, it makes sense to attach higher interest rates to the loan because the company that is offering the money would make little to no profit otherwise. Plus, used car loans are usually shorter in duration.

2. Debt to income ratio

This fancy concept is simple: the more money you owe, the harsher the loan terms are. The reason for this is that if your income is not mathematically able to sustain a larger loan, the lender will have less confidence that you will pay the debt back.

By presenting you with harsher terms, the financial institution is basically making sure that they will recover as much money as possible.

3. Credit Score

A credit score is a type of rating that determines the borrowers’ “credit worthiness”. Banks and credit card companies utilise this system in order to estimate the risk of lending the client money.

Your credit score is one of the biggest factors that will determine the interest rate on the loaned car. So, before going through with this decision, make sure your score is at a reasonable level and decide if it is worth it.

4. Employment history

This is linked to the third entry, because if you have a stable, full-time job, you will be less likely to take impulsive, risky loans, and your credit score will be at a reasonable level.

Plus, lenders are more willing to give out loans to a fully employed 40-year-old adult than to a 22-year-old kid who works part time at a fast food restaurant. So, if you fall into the latter category, you will surely have a higher interest rate on your car.

5. The number of loans that you have taken

If you take or apply for a certain number of credits in a small window of time, the lender of choice will feel anxious about giving you a loan so you should avoid having a busy credit history.

All these applications will stick to your credit score and can even damage it, so be careful with the number of loans you want to take.

6. Residential status

People who own their own houses, who are planning to buy one or have the financial power to do so usually receive smaller interest rates on their cars than individuals who are renting.

Still, this does not necessarily mean that you will get a worse interest rate. It all depends on the speed of relocations – if you are renting on the long term, banks will not feel so uneasy about lending you money.

7. The amount of savings that you have

Lenders will want to know how much money you have put aside in savings because this shows stability, consistency, and a general healthy financial responsibility.

This, in turn, will demonstrate that you have the capability to pay the loan back in time, and the bank will attach a smaller interest rate on your car.

As you can see, there are many factors that determine your car loan interest. What are your thoughts? Are you pondering on taking a loan for a new car?

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