Factors That Impact Interest Rates
Getting an auto loan isn't an easy task and before the loan is accepted there are various items considered by a lender.
Understanding these factors will help you to prepare your application and take into account all available offers.
Five key factors that matter are:
- Credit Score - The higher your credit score, the lower interest rate you’ll be getting. It is a key point for all lenders to determine your creditworthiness.
- DTI-ratio - Most lenders also review your debt-to-income ratio before approving the application. If you have a higher DTI, you might get lesser amounts with more stringent terms.
- Down Payment - The money you put in as down payment also affects the approval. If you put a lower down payment, most lenders will hesitate to approve your application.
- Repayment Term - The length of the loan is another factor that many lenders consider before approving an auto loan.
- The Vehicle Itself- The overall cost of the car, its age, and other factors impact the final decision. Ideally, new cars attract a lower rate.
Compound Vs Simple Interest
It is important to consider more than the interest rate when evaluating the terms of a loan.
Two loans can have similar principal amounts, interest rates, and repayment terms, but substantial interest disparities, especially where one uses the simple interest and the other uses a compound interest.
In easy words, a simple interest rate is calculated on the outstanding principal.
On the other hand, a compound interest takes into account the outstanding principal alongside the accrued interest.
This interest compounds with time. For instance, a loan of $10,000 at 10% for 3 years means an interest of $1,000 per year. The same loan at compounded interest will add up to $3,310 after 3 years.
The longer the term, the greater the interest amount.
Why Do Lenders Make It So Hard To Pay Auto Loans Early?
Banks and lenders are in the business of making money through the interest accrued on loans.
If they allow borrowers to pay off the debts ahead of time, they’ll run into losses. It is done deliberately so lenders don’t lose out on the interest.
Thus, most lenders have started providing auto loans based on a precomputed interest.
If you make additional payments, the concerned lender will apply the extra amount to the outstanding interest over the term of the loan.
So, no matter how quickly you pay, you’ll mostly end up paying the same amount.
What Is Precomputed Interest?
Some lenders also use a precomputed interest format.
They will consider the total term of the loan to calculate the interest. This will be predefined.
If you have a precomputed auto loan, the monthly payments don’t change even when you make additional payments or pay off the debt sooner than the agreed term.
For instance, say you took a loan of $10,000 at 5% for 3 years.
The calculation for the loan amount would include the principal plus the origination fee (or other charges) plus interest.
In this case, total interest will amount to $790. Accordingly, the total balance at the start of the term is $10,790.
The Best Interest Calculators
Calculating the overall cost of an auto loan will help you better understand the monthly installments so you can effectively plan your budget.
There are a lot of online interest calculators that you can try.
It will also help you get an upper hand when it comes to negotiating the best deals.
Some of the trusted online interest calculators that you must check are:
- Kelly Blue Book
Getting the right car loan is more complicated than it seems.
Improving your credit score, allocating a larger down payment, and calculating the different rates and quotes will propel you to a better negotiating position.
The interest rate is just one factor, making it extremely important that you review the terms and speak with the preferred lender before you sign any contract.
Additionally, use the calculators mentioned above to better forecast your budget and secure a good deal.