A Breakdown Of Auto Loan Payments
The monthly amount that you pay on an auto loan is decided by multiple factors like the sale price of the car, the amount of down payment you will pay, your credit rating, income and debts, sales tax, processing fee, and more.
The reason it can get so confusing is simply because shoppers aren’t aware of the contributing factors. To avoid any surprises, here’s a breakdown of auto loan payments to help you build a better estimate and plan your budget with ease.
Size Of The Loan
One of the important aspects of an auto loan repayment is the total amount you borrow. If you request a higher amount, you’ll end up paying a higher monthly installment. Usually, the loan repayment amount will include taxes, fees, interest, and charges. This figure will exclude any down payment and trade-ins.
For example, Sam and Kelly took loans of $30,000 and $40,000 for 5 years at 6% rate. In this case, Sam will pay a total of $34,799 over the term of the loan and a monthly payment of $580. On the other hand, Kelly will be paying a total of $46,399 over the term and a monthly payment of $773. As you can see, the higher the amount you borrow, the higher your monthly payments will be.
Another factor that impacts your loan payments is the duration of the loan. Generally, a shorter repayment term offers the best value. However, most borrowers opt for extended terms as it helps lower the monthly payments. Still, they often overlook the fact that longer terms also mean that they’ll be paying more interest over the life of the loan.
Let’s say you take an auto loan of $25,000 for 3 years at 5%. This means you’ll pay total interest of $1,974 by the end of the term. If you take the same amount for a 5-year period, it means you’ll end up paying $3,307 as interest. Of course, the monthly amount will be lower, but you’ll also have to bear the extra interest which could’ve been otherwise used to meet some other financial needs.
Your credit rating decides the rate you’ll be offered by the lender. If you have a good score, you’ll get the best rates, and if you have a low score, you’ll receive higher rates. Most lenders will check your FICO score to determine the risk of lending you money.
As of May 2020, borrowers with stellar scores (750 and higher) can expect rates as low as 3.60% for a 5-year loan on a new car. The median FICO score for getting a comparatively good rate is 711. If you have a rating that’s lower than this, you may have to settle with rates ranging between 7.02% to 15.24% or even higher.
Most lenders will specifically look into your debt-to-income ratio (DTI) which is the percentage of your monthly income that goes towards making payments on current debts. In general, lenders prefer a DTI ratio ranging between 28% to 38%. If you have a low DTI ratio, it increases your chances of accessing better rates and lower monthly payments.
Tips For Lowering Your Auto Payments
Here are some evergreen ways to ensure that you get an affordable monthly payment:
- Get A Lower-priced Car - Try choosing a car that costs less than your proposed budget. This will ensure that you need to apply for a more affordable amount, which in turn will lower your monthly repayments.
- Build Your Credit Rating - If you have a low or moderate credit score, it is a good idea to start building the score by making timely payments on existing debts.
- Pay A Higher Down Payment - Try paying a higher down payment given it decreases the total amount you need as a loan, thus lowering monthly payments.
- Decrease Your DTI-ratio - If you have multiple ongoing debts, try to pay off a few before applying for an auto loan. A lower DTI-ratio will help you secure better rates.
- Choose An Extended Term - While a longer repayment term guarantees smaller monthly payments, it also means that you’ll be paying more interest over the life of the loan. Consider this option thoughtfully.
It is important that you consider your financial situation and current debts before applying. You need to make sure that you’ll be able to make timely payments on the loan as every missed payment will impact your credit health.
Take some time to consider your budget and goals before moving forward with the application.