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What Determines Your Rate

September 30, 2010 by

Chances are you will have to finance any car you purchase by obtaining a car loan. The interest rate you pay on that loan is the major factor on how much it will cost to pay the loan back. Even the difference of a half of a percentage point can significantly impact the dollars you end up spending to finance the loan.

Following are five factors that will influence the interest rate you end up paying.

Cost of the Loan to the Lender

This is a factor that you don’t have control over. It refers to the amount of money it costs the lender to obtain the money. It begins at interest rates the government sets and goes down the line. For example, if the bank is paying 2% on the money it lends for a car purchase, you might pay 5% for that loan. The more the money costs the lender, the more it costs you.

Credit Score

Your credit score is the biggest factor influencing the interest rate you will pay. Your credit score is calculated from your credit report and covers the five following factors:

  • Payment History (Do you pay on time, all the time?)
  • Credit Inquiries (How often have you applied for credit in the last year?)
  • Debt Ratio (Monthly income vs monthly debt)
  • Length of Credit History (How long have you been accessing credit?)
  • Type of Credit (Secured or unsecured)

The higher the score, the more favorable the terms. You can influence this by making sure your credit report has no errors on it.

Age of the Car

You’ll pay a higher interest rate to finance a used vehicle.

The Lender

Where you obtain the financing will play a major role in the interest rate. For example, dealer financing costs more but they can be a bit more accepting of credit issues. A loan at your local credit union will be at a low interest rate but credit unions tend to lend only to those with the best credit.

If you can do it, a home equity loan may be the least costly. Plus, you can usually deduct the interest payments from your taxes.

There are other factors, of course, but these five are the most influential in setting the interest rate you’ll pay on a car loan . Carefully consider all of them.