How do lenders decide my auto loan interest rate?
Buying and financing a vehicle can seem like a daunting transaction, but you can accelerate the process by being prepared with the right information. One of the most common questions people ask is what determines the interest rate on a car loan.
Factors used to determine auto loan interest rates
Lenders generally use the following factors to determine what interest rate they’ll offer you:
- Credit Score
Probably the most important factor in determining the interest rate on any loan is your credit score. Lenders use credit scores to review your financial responsibility history and reliability which is affected by your on-time payment history, the number of open credit lines you have, how long those credit lines have been open and any negative marks. It's good to know your credit score and review it for accuracy before you discuss your loan interest rate with your lender.
- Debt-to-income ratio
Your debt-to-income ratio is a measure of your ability to repay a prospective lender. For example, having a lot of outstanding debts could lessen your perceived reliability as a borrower and result in a higher interest rate. If you have available income to pay back the loan, you may get more competitive terms.
- Amount borrowed and down payment
Lenders look at your credit worthiness as well as how much they'll need to lend you. Making a down payment signals that you're more likely to pay off your loan in a reliable way. Plus, the down payment reduces the amount of the overall loan. A lender could raise your interest rate to balance their exposure if you decide to purchase or lease without a down payment.
- Age of the vehicle
Generally, lenders charge a higher interest rate on used vehicles than new vehicles. Why? Because older cars usually have more wear and tear and there's more risk for a lender with its depreciated value. It's also good to remember that used car loans frequently have shorter terms. Lenders look at the average life for that vehicle. Understandably, they aren't likely to give you a five year loan if the car may have four years left on it.
- Length of term
The shorter your loan term, the faster the lender can expect to get their money back and the lower the terms may be. Keep in mind that while the shorter term loan may have lower interest rates, your payments will probably be higher and the loan could put more stress on a monthly budget. So, if you'd like to space out your payments, you may pay a premium for the convenience with a higher interest rate.
