When it comes to financing a car purchase, understanding the factors that influence interest rates is crucial. Not all car loans are going to be equal and depending on your personal financial goals, you’re likely to see different interest rates. Here are three factors that impact the interest rate on a car loan.
Secured vs unsecured loans
Lenders offer different interest rates on finance products, primarily based on the level of risk involved. Secured loans, where the car acts as collateral, often come with lower interest rates.
By using the vehicle as security, lenders mitigate their risk as they have the option to repossess and sell the car if the borrower defaults on payments. In contrast, unsecured loans, which do not require collateral, pose a higher risk to lenders. Consequently, they charge higher interest rates to compensate for this increased risk.
Fixed vs variable interest rates
Car loans can feature either fixed or variable interest rates, each with its own set of advantages and disadvantages. Fixed interest rates remain constant for a predetermined period of time, making it easier to budget for borrowers by ensuring consistent monthly payments. On the other hand, variable interest rates fluctuate based on market movements.
While variable rates offer the potential for lower initial payments, they also introduce uncertainty, as repayments may increase if interest rates rise. Whether fixed rates are higher or lower than variable rates depend on the lenders’ assessment of what might happen to interest rates in the future.
Impact of Credit Score
Your credit score, also known as a credit rating, significantly influences the interest rate you’ll receive when applying for a car loan. Lenders assess your creditworthiness by examining your credit history, including your track record of making debt repayments on time.
A good credit score improves your chances of securing a loan at a lower interest rate, as it indicates responsible financial behaviour in the past. On the flip side, a poor credit score represents more risk to lenders, leading to higher interest rates or potential rejection of your loan application.
Before applying for finance, it’s advisable to check your credit score with the help of a finance broker and take steps to improve it.
