How Do Lenders Decide Your Car Loan Interest Rate?

You have to pay interest charges on a car loan unless you're able to qualify for a zero percent interest rate offer. Lenders determine your interest rate based on your credit score, the vehicle you finance, where you live, the federal funds rate, and more.

4 Factors That Affect Your Interest Rate

Paying interest on an auto loan is a part of the financing process most of us have to deal with, because interest is the cost of borrowing money. Since interest rates are rising, this means that even consumers with the best credit may not qualify for the same rate they received even two years ago.

So, how is your interest rate determined, and how can it differ from someone else buying the same car? These factors all help determine your interest rate:

  1. How Do Lenders Decide Your Car Loan Interest Rate?Your credit score – Your credit score is the first thing auto lenders look at, and where your credit falls plays a big role in the interest rate you qualify for. The better your credit, the lower your interest rate is likely to be. If you have bad credit (below 600), you can expect to qualify for an interest rate in the double digits.
  2. The state you live in – Each state has laws that determine the maximum interest rate lenders can charge borrowers.
  3. Your vehicle choice – New cars typically come with lower interest rates than used vehicles. In many cases, the older a car is and the higher the mileage, the higher the interest rate is going to be to offset the increased risk.
  4. Federal funds rate – The Federal Reserve, the country's central banking system, sets the federal funds rate. This is what banks charge each other, and it influences what banks offer to consumers as a result.

How to Qualify for a Low Interest Rate

If you’re one of the many Americans struggling with bad credit, how do you go about getting the lowest interest rate possible? The key is to watch your credit, and take positive steps toward improving it.

Paying all of your bills on time, keeping your credit card balances low, paying off substantial debt, and even adding lines of credit to responsibly manage could help raise your credit score and qualify for a lower interest rate.

But what if you can’t wait for your credit to improve and you need a vehicle now? The good news is that taking out a subprime auto loan can help you improve your credit, the bad news is you’re going to have to pay a higher interest rate until your credit score improves. According to Experian, car buyers with subprime credit (a credit score between 501 and 600) received an average interest rate of 12.17 percent on new vehicle loans and 16.78 percent on used car loans in the fourth quarter of 2018.

As long as you keep up with the payments, you may not have to keep your high interest rate. You have the option to refinance your auto loan, and you may be able to qualify for a better interest rate after around two years have passed.

Looking for a Dealership to Work With?

There’s typically no avoiding paying interest when your credit is less than perfect, but you can always work toward improving your credit to lower the interest rate you qualify for.

In fact, taking out a subprime car loan and keeping up with the monthly payments can help improve your credit score over time. If you need help finding a lender that specializes in bad credit, The Car Connection can help.

We work with a network of dealerships all across the country that want to help you get the vehicle you need. Our service is free and doesn't put you under any obligation. Fill out our online auto loan request form to get started right now!

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