Understanding Car Loan Interest Rates

by Alissa Johnson, Consumer Loans

May 12, 2021

Topics:

  • Auto Loans


a couple meets with a lender to sign paperwork for the best car loan interest rate

When buying a car, most people finance some or all of the loan amount. The price of new cars continues to climb as each decade passes, and few have enough money saved to write a check for the full amount.

The interest you pay on your car loan is an important factor in the total cost of your car. Ideally, you want to find a car loan with the best rate and the shortest term to save as much money as possible on the financing costs.

Interest rates for car loans constantly fluctuate. It isn’t something that you can do anything about. However, that doesn’t mean you can’t get a great deal on a car loan. There are some things you can do to keep your monthly payments low and to save money on interest.

Common Car Loan Terms to Know

It’s worth taking the time to review some common terms that you are likely to see as you shop around for a loan. Being able to understand car loans can help you know whether you are getting a good interest rate. 

Interest Rate and APR

You will encounter both interest rates and annual percentage rates (APR) when reviewing car loans. The two terms are similar, but the APR includes extra information that can help you determine which loan is the best deal.

Interest is the money you pay a lender for the use of the money you borrow. The interest rate is usually expressed as an annual percentage of the loan amount.

The APR includes the interest rate, but it also includes lender fees. The additional information the APR provides gives you a more complete picture of how much you are paying a lender for the borrowed money. At Fibre Federal, we charge no lender fees, so your APR is truly only the interest you pay.

Amortization

Amortization refers to making monthly payments on the money you borrow until it is repaid. For example, if you borrow $20,000 and make fixed monthly payments for six years, the loan is amortized for a period of six years. 

Maturity date

The maturity date is the date that the loan is expected to be paid in full. If you have a loan term of 60 months, the maturity date would be at the end of the 60 months.

Default

Default on a loan occurs when you do not follow the loan agreement. The most common reason for default is failing to make the required monthly payments on time.

Loan term

The term refers to the length of time needed to repay a car loan. The most common term for a car loan is five years, although it can be longer or shorter.

Car Loan Factors You Can Influence

Although car loan interest rates are largely determined by forces outside of your control, this doesn’t mean you have to accept a bad deal. There are some things you can do to save money on both the price of the car and on the amount of interest you pay on the financing.

Your credit history

A major factor in qualifying for a car loan is your credit history. If you have poor credit or limited credit history, you may have trouble qualifying for a loan. Also, lenders consider those with high credit scores to be lower risk than other borrowers and often reward them with better loans. Keep in mind that at Fibre Federal Credit Union, we practice Rate Equality, so every qualified member receives the same low rate!

You are legally entitled to obtain one free credit report from each of the three credit bureaus (Experian, TransUnion, and Equifax) each year. If you find incorrect information on one of the reports, you can dispute the item with the reporting bureau and possibly have it removed to improve your score.

Down payment

The amount of down payment you make when buying a car can be a factor in determining how much interest you will pay and how much your monthly payments will be. Ideally, you want to make as much of a down payment as possible.

With a higher down payment, you may be able to structure your loan for a shorter term. This will help you to save money on the interest.

Buying new or used

Whether you buy a new or used car can have a major impact on how much you pay, your monthly payment, and the total amount of interest you pay on your loan. New cars depreciate rapidly and can lose as much as half of their value in the first five years of ownership.

A great way to potentially save thousands on a car is to purchase a gently used car. A low-mileage used model made by a company that is known for its quality and reliability will still have the majority of its life ahead of it – but for thousands less than a new one. Not only will you save big on the purchase price, but you may also be able to save money on interest by financing it for a shorter term.

Where you obtain your financing

If you go with a loan offered by a car dealership, you may not be getting the best deal. It’s worth your time to shop around for car loans before visiting dealerships and test driving cars to find the financing option that gives you the best interest rate possible. It’s recommended that you get pre-approve before you visit a dealership, or you can also ask for credit union financing right at the dealer. They can arrange a Fibre Federal loan for you while you make your purchase. Most local auto dealers participate in Credit Union Direct Lending (CUDL).

Be sure to check with your local banks and credit unions to see what they have to offer.

The main difference between banks and credit unions for car financing is that credit unions tend to have lower interest rates and fees. Credit unions are financial institutions that are owned by their members. Structured as non-profits, they are primarily focused on serving the needs of their members instead of turning a profit for shareholders.

Before You Buy a Car

A car is a major purchase, and it’s something you want to take your time with to make sure you find both the best car for your needs and the best loan. Before you visit car dealerships, it’s important to research which brands are high-quality and which models have the features you are looking for.

It’s also important to make sure you meet the requirements for car financing. Having all of the required information before you apply can save time and ensure a smooth process.

See Requirements for Financing a Car