There are few purchases more exciting than buying a car. Whether you’re looking at new or used cars, there’s a lot to think about. While you may be considering your preferences for body style, drivetrain, and features, you should also be considering your financing options. Whenever you make a major investment, it’s important to stay well-informed and confident about what you’re doing. Unless you’re able to cover the entire cost of your new car upfront, you’ll need to know about auto loans.
When it comes to any type of loan, your interest rate can dramatically affect your total interest – the amount of money you end up paying the lender on top of the principal – or original loan amount. Taking out a five year, $25,000 car loan at an 8% interest rate will cost over $5,400 in total interest throughout the full term of the loan. However, the same loan at a 3% interest rate will cost just over $1,900 in total interest throughout the full term.
What Factors Determine Interest Rates?
When a lender considers giving out a loan, they carefully weigh the potential risks and rewards. If a loan is awarded and everything goes well, the lender will receive back the principal, the original amount of your loan, plus interest—their reward for lending out the money. Of course, things don’t always go well. If something goes wrong, borrowers may default on payments, making it difficult for the lender to recover their money. Lenders award interest rates based in part on the likelihood that the loan will be repaid on time and in full. Creditors use a number of factors to decide what interest rate to offer, including:
Credit Score
A person’s credit score is the most powerful tool in predicting credit behavior. It gives insights into past credit accounts, signaling how financially stable the applicant has been. Credit scores range from 300 to 850, with most consumers falling between 600 and 750. Credit scores are shaped by factors such as:
- Bill-paying history
- Current unpaid debt
- Number and type of open loans
- Length of open loans
- Amount of available credit in use
- New credit applications
- Past bankruptcies, foreclosures or debt collections*
*As of July 1, 2022, paid medical collection debt won’t appear on consumer credit reports. In the past, this debt could have stayed on credit reports for up to seven years.
Debt-to-Income Ratio
Debt-to-income ratio is just what it sounds like — a figure comparing your total debt to your income, which helps to determine your capability of paying back an additional loan. If you have a lot of outstanding debts, it might raise concern that you’re not capable of taking on additional financial burden. As a general rule of thumb, it’s recommended to keep your overall debt-to-income ratio at or below 43%.
Down Payment and Amount Borrowed
Making a substantial down payment is a good indicator that the borrower will pay back the loan. It’s a way of putting skin in the game – if the borrower defaults, they’ll lose the vehicle and the down payment.
Age of the Vehicle
Loans for new cars tend to receive lower interest rates. New cars are assumed to be reliable throughout the length of the loan, making for a greater chance of repayment. The older the car, the more its reliability comes into question. Since major mechanical issues can be costly – even exceeding the vehicle value in some cases – giving out loans for older cars is riskier, making for a higher interest rate.
The Length of the Term
The shorter the length of the term, the faster the lender can expect their money back. Because of this, lenders typically give out lower interest rates for shorter terms, and higher interest rates for longer terms. Auto loans typically range from 24 to 60 months, or 2 to 5 years. However, as car prices continue to escalate, 72 and 84 month terms are gaining popularity. With a longer term loan the interest rates may be higher, but as payments are drawn out longer, the overall monthly payment is more affordable.
Car Interest Rates by Credit Score
Although all of the above factors play into auto interest rates, the single most important factor remains credit score. Here’s a breakdown of the average interest rates given out by credit score:
781-850
Average APR for a new car: 3.84%
Average APR for a used car: 3.69%
661-780
Average APR for a new car: 4.9%
Average APR for a used car: 5.47%
601-660
Average APR for a new car: 7.25%
Average APR for a used car: 9.81%
501-600
Average APR for a new car: 10.11%
Average APR for a used car: 15.86%
300-500
Average APR for a new car: 12.93%
Average APR for a used car: 19.81%
*Statistics sourced from Experian's State of the Automotive Finance Market Report: Q3 2022
Apply for an Auto Loan Today
Feeling ready to take the next step? Use our online application to apply for an auto loan from DCU today! Read about the many benefits of DCU auto loans here.
Please note, membership is required to open a DCU Auto Loan. Visit our membership eligibility page for more information.
This article is for informational purposes only. It is not intended to serve as legal, financial, investment or tax advice or indicate that a specific DCU product or service is right for you. For specific advice about your unique circumstances, you may wish to consult a financial professional.
