Car Loan Interest Rates Explained

There aren’t many things more exciting than going through the process of finding and choosing a new car. From the research to the test drive, finding the right one is a fulfilling experience.

A big part of purchasing a car is determining how you are going to finance it. Any time that financing is involved it is important that you are strong in understanding interest rates and how they affect your payments.

While interest rates might seem daunting, you’re in luck because you’ve come to the right place to learn all about car loans and car loan interest rates so that you get the best financing package for your needs.

Continue reading to learn everything you need to know about interest rates when buying a car.

What Is a Car Loan Interest Rate?

Car loans aren’t overly complicated. If you’ve ever purchased a house, the interest rate on a car is very similar to that of a house loan interest rate. 

Basically, the interest rate is a percentage that is added each year to the principal amount of money that you took out in order to finance the purchase. This means that you pay the bank back what you owed plus whatever interest was built up.

When you choose to take out a loan on a car, the bank purchases the car for you. Borrowing money from the bank comes with an agreement that you’ll pay back what you owe in a certain amount of time. 

The bank benefits from this because you’ll end up paying the bank everything that they loaned you, plus the monthly interest on your payments. 

The interest rates on car loans are usually simple interest. Simple interest is front-loaded and experiences amortization as time goes by. This means that your payments at the beginning cover more of the interest and gradually shift to the principal at the end of the paying period.

You also have the option to pay more than the minimum monthly payment. Doing this will reduce your loan balance and the interest that you owe on the principal. 

What Is a Good Car Loan Interest Rate?

A big factor in getting good car loan interest rates is your credit score. Some other factors that will affect the interest rate that you get are your credit history and the loan term preference that you choose when financing the vehicle.

If you have a high credit score and display a history of paying your bills completely and in a timely manner then you will get a better interest rate than if you have a poor credit score or credit history.

Most car loan interest rates are between 3 percent and 14 percent, depending on those factors. With a good credit score, most 3-year loan agreements have a car loan interest rate in the neighborhood of 3 to 4 percent.

When financing a vehicle it is always a good idea to compare your options. A rate comparison website can make that a much easier task.

Understanding Interest Rates and Loan Term Length

When it comes to financing a vehicle, longer loan terms mean that you’ll be paying more interest to the bank. While opting for a longer loan term will make your monthly payments more affordable, you’ll be paying more than what the care is actually worth.

Paying more interest with a longer loan term agreement is something you’re able to avoid if you have a high enough credit score. With a long-term loan and a low interest rate, the amount you pay can be roughly equal to what you’d pay with a shorter-term agreement.

Ways to Reduce Interest Charges on Your Loan

Unfortunately, no matter how great of an interest rate you qualify for, you’ll end up paying some extra money to the bank on top of the principal of the loan agreement. 

Thankfully, there are ways to reduce the interest charges that you’ll face.

Settle an Early Repayment

The amount of money you owe on interest is directly connected to the amount of money that is still owed on the principal amount that you borrowed from the bank. 

If you choose to pay on an unscheduled basis, that step can go a long way towards reducing the interest charges you face. Taking this step lowers what you owe and speeds up the process of paying back the loan.

Choose a Shorter Term of Loan

Since we know that longer loan terms on car loans increase the amount of interest that you owe, a shorter term of the loan is a good fit for those looking to spend less on interest payments.

While choosing a shorter term of car loan will increase what you owe every month, it will greatly decrease the amount you’ll pay towards interest during the term. 

This is a great strategy for limiting how much you pay towards interest, but it is important to ensure that you have the means to make the payments each month.

Put More Money Down

Putting more money down towards the purchase of your car is another great option for decreasing the amount of interest you’ll pay when buying a car. 

Not only will putting more money down help you cut down on the interest you owe, but it’ll also make your monthly payments less costly. You’ll also have to pay them for a shorter length of time.

On the flip side, most times when borrowing money the bank will charge you more per month in interest and payments towards the principal if you put little to no money down at the time of purchase.

Now You’re Ready to Find Your Next Car

Though borrowing money and car loan interest rates might seem overwhelming, they’re easy to understand and there are ways to make them more manageable. 

Understanding interest rates is a great way to ensure that you get the best deal and end up saving money on both interest and principal payments on the money you borrowed.

For more interesting tips and lifehacks on a whole range of topics, be sure to check out more of our articles!