The interest rate on auto loans is an important variable that needs some clarification.
The interest rate defines along with fees and other charges, the total cost of the money you borrow in order to purchase the car. Thus, it will eventually determine how much the car will cost you in the long run. Because of this, the interest rate is not just another clause on your car loan contract but probably the most important one.
Explaining APR
The APR (Annual Percentage Rate) measures the total cost of a loan on an annual basis. This rate includes the interest rate but also any fees and costs like administrative fees, closing costs, etc. It is supposed to include the overall costs of the loan but some fees may be left aside and thus you should still be careful enough to read the fine print of the loan contract prior to signing.
Nevertheless, the APR is an excellent tool to compare different loans and lenders as it provides a wide idea of the loan convenience. The lower the APR, the lower the total costs of your loan on a yearly basis. However, don’t neglect watching closely other loan terms like the loan amount, the loan repayment program and the loan installments that may turn the loan too onerous in other ways.
Factors That Influence Interest Rate
The interest rate you’ll have to pay depends on several factors. Anything that increases the risk implied in the financial transaction will raise the interest rate you’ll have to face and any variable that reduces the risk implied for the lender will lower the interest rate on your car loan. That being said, here are some risk modifiers:
When you can offer a down payment, you are showing the lender that you have saving capacity and that you can manage your finances efficiently, also, you are reducing the amount of money you are borrowing and reducing the debt to value ratio thus offering the lender an asset of greater value than the money borrowed as a guarantee for the loan. All of these act positively and reduce the risk implied for the lender. Thus, a down payment, will guarantee you lower interest rates.
Bad Credit shows the lender that you’ve had a deficient credit behavior in the past and that you have failed to make payments or paid late; that you’ve too much accumulated debt or other financial difficulties. This increases the risk of default and the lender’s possibility to loose his investments and thus, bad credit implies having to face higher interest rates when requesting an auto loan.
In order to compensate this, you can offer a co-signer. A co-signer is a third party that is obliged to the repayment of the loan as well as you. Thus, if you fail to meet the monthly payments, he will be forced to repay the loan by himself. Of course, the co-signer must have a better credit score than the main borrower. This reduces the risk implied for the lender in the financial transaction and thus, will imply lower interest rates too.