Buying a car is exciting—especially when you know what you want in a vehicle, you've found a dealership that has what you're looking for, and you've established a general budget. While all of those details are certainly important, don't make the common mistake of overlooking the financing piece of the puzzle as well.
Not paying attention to what you can afford based on the purchase price, interest rate of your new car loan, and repayment terms can be a costly mistake. When it comes to the total cost of borrowing, you need to understand how the interest rate impacts your financial picture and how you can ensure you're getting the best rate for you. Read on to learn how to get the best possible rate on your auto loan.
Tip for Getting the Best Rate on Your Auto Loan #1: Consider Your Credit
Whether you're financing your new or used car purchase through a bank, credit union, online lender, or the dealership, your credit plays a crucial role in how much the loan will cost over the long haul. That's because the interest rate offered by a lender is directly affected by your credit history. If you have a spotless credit history—meaning no late payments or defaults, manageable monthly payments relative to your income, and no collection accounts—you're likely to get the best available interest rate on your new loan.
Buyers with poor credit often pay more over time, but there are still things you can do to positively affect your interest rate. For example, if you have a less-than-ideal credit history, you may have the option to refinance your auto loan with a lower interest rate after making several on-time payments or boosting your credit in other ways. Offering a sizable amount of cash in your down payment can also show lenders that you're committed to honoring the loan terms. In many cases, this can help persuade them to overlook past credit stumbles and offer you a better loan. No matter how good or bad your credit may be, consider how it will affect your auto loan rate and what you can do to secure the best possible rate.
Tip for Getting the Best Rate on Your Auto Loan #2: Understand the Long-Term Cost
When deciding what you can afford, knowing your monthly payment is a great place to start. That's why many dealership websites offer our online tool to help you estimate that payment based on your credit range, purchase price, and repayment term before making your way to the dealership. However, you'll also want to consider how much a loan is going to cost you in the long run, and that starts with understanding the annual percentage rate (APR).
Having the lowest possible APR on a new car loan means you'll pay less over the lifetime of your loan, even though that may not be immediately obvious based on your monthly payment. For instance, if you get an auto loan for a $25,000 vehicle with an APR of 3%, you'll have a monthly payment of $449 with a five-year repayment schedule. That's a total cost of $26,953 over the life of the loan. If the APR is 7%, your monthly payment on the same car purchase is $495. While the monthly payment isn't that much higher, you end up paying $29,702 over the five years. In other words, that small 4% difference in APR can cost you over $2,500 across the lifetime of the loan—those dollars really add up!
Tip for Getting the Best Rate on Your Auto Loan #3: Know Your Options
Now that you know the importance of a low APR, it's helpful to understand what factors affect that rate. For example, the term of the loan and the age of the vehicle you purchase can both affect your auto loan interest rate.
In some cases, a longer repayment term, like six or seven years, poses more of a risk to your lender than a four- or five-year term. A longer term provides more opportunities for a borrower to default on the loan, leaving the lender to pick up the pieces. If you have checked your monthly payment and can easily afford a shorter term, you could end up with a lower total cost of borrowing than if you extend repayment another 12 months.
Additionally, some lenders offer the lowest possible interest rate for vehicles that are brand new or within one to two years old. The same methodology applies—lenders are less at risk of a car owner defaulting on payment when a vehicle is new. There is also less of a chance for unexpected repairs on newer vehicles, which reduces the risk for both the lender and borrower. Once you understand how loan term and the age of the vehicle you purchase affect your APR, you can make decisions accordingly to get the best possible auto loan rate.
Tip for Getting the Best Rate on Your Auto Loan #4: Aim for Positive Equity
Another factor that a lender considers when underwriting or approving a loan is the equity position. Your equity position is the amount of credit or cash going towards the new loan, and it's possible to have negative or positive equity.
Negative equity is best described as the unpaid balance rolled over from a previous loan. For example, let's say you want to trade in a car for which you still owe $15,000. The dealership, however, has only committed to a trade-in value of $11,000 on your car. That difference of $4,000 represents negative equity. If you make a down payment of $2,500, you can offset that negative equity a bit, but you'll still have a negative equity position of $1,500, which will be added into your new loan.
Positive equity, on the other hand, is best described as the amount by which your new loan amount will be reduced. This can be from your trade-in, cash down, and sometimes even a manufacturer rebate incentive. For example, let's say you want to trade in a car for which you still owe $10,000, and the dealership has committed to a trade-in value of $13,000. That's $3,000 in positive equity. Now, let's say you also qualify for a $500 college graduate rebate and have a $1,000 cash down payment. That's $1,500 more in your favor, so you have a positive equity position of $4,500, which will be subtracted from your loan amount.
As you can see, offering a larger down payment and/or entering a loan agreement with positive equity can help you secure a smaller loan with a lower interest rate. Any time a lender is financing more than the value of the vehicle, they are more likely to charge a higher interest rate to offset the increased risk, which means higher costs for you over time.
Know What's in Your Control When Securing an Auto Loan
With these tips in mind, you now know what you can do to secure the best possible rate on your auto loan. Remember—the lower the risk for the lender, the lower the interest rate they are going to provide. Having a high credit score and strong borrowing history will provide you with the largest amount of financing options and lowest rates. Financing a newer car for a shorter term, generally 36-60 months, can also make your rate lower. Finally, cash down and positive equity will sweeten the deal for both the lender and borrower. Be sure to know your options beforehand, then work with your dealership to understand the interest rate and terms of the loan you choose for the best possible deal on your new vehicle.