If you’re shopping for a new car, you may also be shopping for an auto loan to pay for it. Investopedia’s auto loan calculator and regularly updated ratings of the best auto loan rates can help you find a good loan with an attractive interest rate. Here’s what else you need to know to get the best rate possible.
- Interest rates on car loans depend on a variety of factors, including your credit score, the length of the loan, and the car itself.
- While car dealers often offer promotional interest rates, occasionally as low as 0%, they aren’t always the cheapest way to finance a car. Banks and credit unions may have better rates.
- You can often negotiate for a better loan rate, especially at the dealership.
How Car Loan Interest Rates Work—and How to Get a Good One
What constitutes a “good” interest rate on a car loan will differ per borrower.
The interest rates on auto loans depend on a variety of factors. Some of these, like the benchmark interest rates set by the Federal Reserve, are beyond your control. Other variables, however, are very much in your control. The most important one is your credit score. Applicants with higher credit scores will qualify for loans with lower interest rates, all else being equal.
For example, the Experian credit bureau recently reported that the most creditworthy borrowers (with credit scores of 720 and above) paid an average interest rate of 3.65% on a new car loan, while the least creditworthy (with scores of 579 or below) paid an average interest rate of 14.39%.
One way to get a good interest rate on your auto loan is to improve your credit score. Two ways to do that are to make sure you pay all your bills on time and to keep your credit utilization ratio low. Your credit utilization ratio compares how much credit you are using at any given time with the total amount of credit available to you. If your credit cards are all maxed out, for example, then you will have a poor credit utilization ratio.
Click Play to Learn How Interest Rates Work on Car Loans
The length of your car loan also makes a difference. Car loans today often run from 24 months (two years) to 84 months (seven years). The longer the loan term you choose, the lower your monthly payments. But your interest rate is likely to be higher, and you will end up paying more interest in total over time.
The car itself also plays an important role. Generally speaking, interest rates are lower on new cars than on used cars. There are a variety of reasons for this, but a major one is that used cars are riskier to the lender. A new car is less likely to break down or become unusable. Remember that until you pay off your auto loan, the bank still owns the car and wants to make sure that its asset is in good condition.
The Experian study mentioned above found that the most creditworthy borrowers paid an average interest rate of 4.29% on a used car loan, while the least creditworthy paid an average interest rate of 20.45%.
Another reason that new car loans tend to have lower interest rates is that car manufacturers and dealerships often offer promotional rates on new cars as an incentive to buyers. Interest rates as low as 0% are not unheard of when buying a new car from a dealer.
Being preapproved for a car loan by a bank or other lender can give you leverage in negotiating with car dealers.
More Ways to to Get a Good Interest Rate on a Car Loan
Aside from raising your credit score, opting for the shortest loan term you can afford, and choosing the right car, there are several other ways to get a better loan rate.
Shop around. A 0% promotional offer from a manufacturer or dealer could be hard to beat. Otherwise, you may find that dealer financing is more expensive than going through your local bank or credit union or using an online lender. With a bank or credit union, you can apply for preapproval, which will tell you how much money they are prepared to lend you and at what interest rate. Being preapproved for a loan also gives you leverage in negotiating with the car dealer.
Negotiate. Just like the price of the car, the interest rate you’ll pay on a car loan can be negotiable, particularly at the dealership. Car dealers often work with one or more lenders. After they have reviewed your financial information, the lenders will propose an interest rate to charge you, known as the “buy rate.” The dealer, however, is likely to pad that rate and offer you a higher one as a way to increase their profit margin. That gives you some room to negotiate.
Get a cosigner. If a low credit score is the problem, then asking a relative or other person with a better score to cosign the loan could help you get a lower rate.
Put more money down. If you have the cash to spare, making a larger down payment will reduce the size of your loan—and, in some cases, will entitle you to a lower interest rate. It can also mean smaller monthly payments and paying less interest over the life of the loan.