Understanding the Role of Interest Rates in Car Financing

If you’re considering purchasing a new or pre-owned vehicle and need to borrow money for the purchase, there are various loan options available. Regardless of the loan agreement you select, interest will be part of the equation.

Lease, sale, or return

Personal contract plans involve leasing the vehicle for a monthly payment instead of owning it outright.

Hire purchase agreements also entail fixed payments but offer the choice to purchase the car at the end for an additional fee.

Conditional sale agreements are designed for those who intend to own the car at the agreement’s conclusion. Once the final installment is paid, the vehicle becomes your property.

Auto loans

There are also auto loans available, with two primary types in the market – personal loans or fixed sum loans.

Personal loans are a suitable option for individuals with a good credit rating who wish to own the car from the start.

Fixed sum loans are secured by the vehicle. Unlike personal loans, you don’t fully own the car until the loan is repaid. This means you can’t modify or sell the car while the loan is being paid off. However, one advantage is that you can receive assistance from the lender if there are any issues with the vehicle during the initial six months.

In your best interest

So, how do interest rates work on auto loans? Simply put, the interest rate determines the additional amount you will pay for the vehicle, on top of the borrowed sum.

If you obtain an auto loan, the actual cost of the vehicle is determined by the interest rate. It’s crucial to secure the best possible deal, as a lower rate means you’ll repay a smaller amount.

You will borrow a specific sum to purchase the car – either the full price or the price minus a down payment, if applicable. The interest is then added to this amount to determine the total amount you’ll pay. This total is divided into monthly payments.

Auto loans generally have repayment periods ranging from one to seven years, with most loans having terms of two to five years. Typically, the more you borrow, the more favorable interest rate will be applied. This rate is known as the annual percentage rate, or APR. When considering auto loan options, you can compare the APRs to find the best value.

However, it can be more complex than it appears. Advertised rates are ‘representative’ APRs. Regulations dictate that at least 51% of applicants must receive that rate, but the remaining 49% may not. Some, or even many, of that 49% may be offered a higher rate.

Points to ponder

Several factors can impact the interest rate you pay. As mentioned earlier, smaller loans generally attract higher rates. Therefore, if you’re borrowing a modest sum, you’ll likely face an elevated interest rate.

Your credit score will also significantly influence the interest rates available to you. A favorable score indicates lower risk to lenders, leading to lower interest rates. Conversely, a poor credit rating positions you as a higher risk borrower, potentially limiting your access to competitive interest rate deals.

If you currently have an unfavorable credit rating, it may be advantageous to take measures to enhance it. Various approaches can be taken. For instance, ensure you are registered on the electoral roll if you haven’t already done so. Additionally, strive to meet your existing loan and credit repayments promptly, as this will contribute to improving your score.