Buying a car can sometimes feel like a massive undertaking. Beyond the initial, often hefty price tag, there are a number of stressful and potentially expensive decisions to make about add-ons, warranties and, most importantly, financing. We've received a lot of questions regarding what specifically determines the interest rates on your auto loans. Read on to find out more.
1. Your Credit Score
If you're a Credit Karma member, you probably already realize how important your credit score is to your financial health. When it comes to the long-reaching implications of that special number, your transportation costs are no exception. The single biggest factor in determining your auto loan rate will likely be your credit score, and you should come prepared to any negotiations knowing where you stand.
Lenders use credit scores to gauge your financial responsibility, history and reliability. Your score can be affected by factors like on-time payment history, number of open credit lines, age of credit history and derogatory marks. If you need a refresher on what your credit situation looks like, check out your report details on Credit Karma.
2. Debt-to-Income Ratio
Debt-to-income ratio is a simple and intuitive measure of your ability to pay a prospective lender back. Having a lot of money in outstanding debts could decrease your perceived reliability as a borrower, and result in less friendly terms. The more income you have available, the more confidence the lender will likely have that you will pay them back, and you may be rewarded with more competitive terms.
3. Amount Borrowed and Down Payment
Lenders determine auto loan rates not only by assessing your credit worthiness, but also by considering how much they're going to have to lend. Paying a significant portion of your auto loan via down payment can signal to a prospective lender that you can and will pay off your loan in a reliable manner. Similarly, borrowing an especially large amount of money or offering little or no down payment will up the risk for the lender, probably resulting in a higher interest rate to balance out the lender's exposure.
In basic terms: The more money you can pay upfront for your new car, the lower your interest rates are likely to be.
4. Age of Vehicle
Generally, loans given out for used cars come with higher interest rates than those for brand new vehicles. This may seem counterintuitive, but it makes sense considering that older cars have already begun to depreciate in value. Car dealerships have less to gain by selling less expensive cars, and used car loans often come with shorter terms. These realities make it more likely that a prospective lender will try to recoup some value by considering higher auto loan rates on older cars.
5. Length of Term
Just like with the other factors, lenders will try to hedge their bets when it comes to the length of your term. The shorter the term of your loan, the quicker the lender can expect to get their money back, and the friendlier the terms usually will be. Keep in mind that while a short-termed loan may come with noticeably lower interest rates, your payments will likely be higher and the loan could put relatively more stress on your budget. If you'd like to space the repayments out over a longer time to provide yourself with more cushion, please keep in mind that you'll probably pay a premium for the convenience with higher interest rates.
Though the process may feel complex, working your way to a good result is often possible. As always, Credit Karma is here to help you with educational resources, including information on long-term trends in interest rates and an advice section full of members with similar experiences. Hopefully, with these factors in mind, you'll be able to go into the negotiation process feeling self-assured and ready.
About the Author: Mike Goldstein is a Content Writer at Credit Karma. Since joining the team in June 2013, he's been delivering the financial know-how on the daily. When away from work, you can find Mike watching hockey, Twittering for hours and frequenting trivia nights.
Editorial Note: The opinions you read here come from our editorial team. While compensation may affect which companies we write about and products we review, our marketing partners don't review, approve or endorse our editorial content. Our content is accurate (to the best of our knowledge) when we initially post it, but we don't guarantee the accuracy or completeness of the information provided. You can visit the company's website to get complete details about a product. See an error in an article? Use this form to report it to our editorial team. For questions about your Credit Karma account, please submit a help request to our support team.
Advertiser Disclosure: We think it's important for you to understand how we make money. It's pretty simple, actually. The offers for financial products you see on our platform come from companies who pay us. The money we make helps us give you access to free credit scores and reports and helps us create our other great tools and educational materials.
Compensation may factor into how and where products appear on our platform (and in what order). But since we generally make money when you find an offer you like and get, we try to show you offers we think are a good match for you. That's why we provide features like your Approval Odds and savings estimates.
Of course, the offers on our platform don't represent all financial products out there, but our goal is to show you as many great options as we can.