Buying a car is one of the biggest investments you’ll make in your life, and getting a good deal on your car purchase is essential to keeping a balanced personal budget.
But the car itself isn’t the only reason to shop around. You also want to find the best deal on your car loan.
Interest rates can vary significantly from lender to lender depending on the car you buy, the size of your down payment, and the length of your loan, but the most influential factor when it comes to auto financing is your credit score.
Knowing the average interest rates for each credit score range is helpful to be better prepared to negotiate the best deal for yourself.
What are car loans, and how do they work?
Cars can be expensive, and not everyone has the resources to buy a car with cash. That leaves you with two options: you can lease the car from the dealership or take out a car loan to help cover the purchase cost.
Three factors determine how much you end up paying for your car loan: the total amount of the loan, the duration of the loan, and the interest rate. Together, these factors help establish your monthly payment.
The interest rate on a car loan is sometimes referred to as the annual percentage rate (APR). The APR is calculated as a percentage of your monthly payments and includes the loan’s base interest rate plus any extra fees.
According to Experian’s State of the Automotive Finance Market report for the second quarter of 2021, the average APR rate on a car loan is 4.09% for new cars and 8.66% for used cars.
You have many options to choose from when shopping for a new car loan. Many car dealerships offer financing, but you can also find auto loans at financial institutions like national banks, credit unions, and online lenders. Top auto loan lenders include LightStream, Bank of America, Capital One, Carvana, and myAutoLoan.
As with any loan, take the time to shop around and find the best deal for you.
Factors that influence car loan interest rates
Many factors influence the interest rates lenders offer you for your car loan. Let’s take a look at the main ones:
Your credit score
As with most loans, your credit score is a major determining factor in the interest rate you receive on your car loan. A bad credit score signals to lenders that you might be at greater risk of defaulting on your loan. Auto lenders apply a higher interest rate on loans to compensate for that risk.
Whether you’re buying a new or used car
Loans for new cars tend to have lower interest rates than used cars because used cars have higher risks. New cars have a better resale value and make for better collateral on the loan.
The duration of the loan
Longer loans have higher interest rates because they’re considered higher risk. Lenders worry that borrowers with a longer term might eventually default on their payments. The value of your car also declines over time, and lower collateral value leads to higher interest rates.
The make, model, and year of the car you’re buying
Since some cars have better resale values than others, the make, model, and year of the vehicle you’re buying impacts the interest rate you receive.
Your down payment
The bigger your down payment, the smaller the total loan you need. This results in a better loan-to-value ratio, which is the relationship between the amount you owe on the loan and the car’s value after depreciation. A better loan-to-value ratio means a lower interest rate.
Average interest rates for each credit score type
Here are the average interest rates for new and used car loans in each credit category:
As you can see, better credit scores result in considerably lower interest rates, which means lower monthly payments. There isn’t a minimum credit score for a car loan, but a credit score below 500 makes it much harder to be approved. Scores over 650 are more likely to be approved.
Throughout a loan, differences in interest rates can lead to a significant difference in the total cost of the loan.
For example, let’s look at a $20,000 loan for a used car, spread over 5 years (60 months):
For a buyer with a prime credit score (661–780), monthly payments would come to about $382. For a buyer with a subprime credit score (501–600), monthly payments cost about $498.
That means the buyer with better credit would pay about $2,915 in interest over the life of the loan, while the buyer with lesser credit would pay around $9,894, a difference of almost $7,000.
What can I do if I have a bad credit score?
If your credit score is low and you want to improve it before applying for a car loan, you can take several steps.
Pay your bills on time
When you make late payments on bills and credit cards, your credit score suffers. Keep track of your due dates, and be sure to make at least the minimum payment. This will improve your credit history, which is the largest factor in your credit score.
Keep low credit card utilization
Credit card utilization is the amount of available credit to use. To keep this number low, you should use your credit card as little as possible or try increasing your credit limit.
Avoid applying for credit or loans too often
Applying for a credit card or a loan leads to a hard inquiry into your credit report. Too many hard inquiries within a short window of time harms your credit score so keep applications to a minimum.
Other factors besides your credit score that can help you
A bad credit score doesn’t mean you won’t get a car loan. If you have poor credit and still want to apply for a car loan in the short term, you can improve your chances of getting the best rates.
Make a larger down payment
The bigger the down payment you make on your purchase, the smaller the total loan amount, and the easier it’ll be to get approved. You’ll also get better interest rates.
Bring documents showing financial stability
Sometimes a bad credit score can stick around for a while even after your financial situation has improved. If you feel that your credit score doesn’t reflect your current finances, bringing documentation like pay stubs, tax returns, or proof of address can help show lenders that you’re reliable.
Consider a co-signer
Getting a co-signer with good credit to take on partial responsibility for your loan can also help you qualify and get better interest rates.
Refinancing
Keep an eye on your credit score after you get a loan. If you’ve made your payments on time, you might be able to refinance your auto loan at a lower rate.
The bottom line
Buying a car can be a stressful investment, especially if you’re struggling with a low credit score. But if you take the time to do proper research, shop around, and follow the steps outlined in this guide, you’ll improve your chances of finding the car loan that works for you.
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