Factors that Influence Interest Rates on Car Loans

It is still a very good time to buy a new car, especially if you’re funding the purchase through an auto loan.

Yes, we are aware that interest rates are on the rise, but the increase is yet to translate to significantly higher borrowing costs. At the same time, industry experts note that there is still intense competition among lenders that remains effective in holding down interest rates imposed on car loans.

CNBC Money columnist Christopher Palmer identified an important factor that has a great influence on the cost of a car loan—your chosen lender. Thus, he advises borrowers to continue to shop around to find a better deal from various loan providers.

Before going to the dealership to buy your dream car, it is ideal to first find and get a pre-approval for a car loan from a good lender that offers competitive rates. If you are still getting started on this process, it would help if you will first know and understand these important factors that influence car loan interest rates, and what you could do to navigate around them.

1. Your credit history

People who have maintained good financial discipline, indicated by their higher credit scores, have the advantage in securing a low-interest loan. All credit and loan providers will always check a borrower’s credit history before giving approval and offering rates. Lenders don’t want to take the risks with borrowers who pay dues delinquently or worse, default on loans. To reward consumers with impressive credit scores they are offered lower interest rates on car loans.

“All credit and loan providers will always check a borrower’s credit history before giving approval and offering rates.”

2. Your debt-to-income ratio

Other than your credit score, your debt-to-income ratio is also considered as a good indicator of your capacity to repay a loan. Having numerous outstanding debts can affect lenders’ perception about you, prompting them to consider you a higher risk borrower that in turn, leads onto higher interest rates. If you have a high regular income and low or zero debt, you’re sure to obtain a favorable car loan.

3. Down payment

You can further impress a lender by committing to make a huge down payment for your car purchase (about 20% of car purchase price is ideal). Such a gesture is always interpreted by loan providers as a sign that you will be able to pay off a loan in a very reliable manner. Not paying a down payment (or paying a very minimal amount) automatically translates to higher interest rates.

“You can further impress a lender by committing to make a huge down payment for your car purchase.”

4. Car model and age

Lenders will take your purchased car as collateral for your car loan. That is why they prefer to provide an auto loan to borrowers who are buying a new and good car model from a reputable brand. For them, it is always nice to repossess a car that is still of good value in case you fail to meet your obligations or default on your car loan. Also take note that purchasing a new car merits lower interest rates compared to buying a pre-owned one, in the same way, that lenders prefer more valuable cars in case borrowers fail to repay.

5. Term of loan

In general, shorter-term car loans come with higher interest rates compared to loans with longer terms. However, if you will analyze the comparison more, you’ll see that in the end, a shorter-term loan will add up to an amount that is much lower compared to the total amount you would repay for a longer-term one. But you should also consider the fact that long-term loans offer monthly repayments that are easily manageable and are friendlier to your wallet in the short term.

“A shorter-term loan will sum up to an amount that is much lower compared to the total amount you would repay for a longer-term one.”