One of the first things you need to do before you go out to the dealership or bank is to establish your car budget. Putting a peg on how much you need to spend on your monthly rates will come in handy when you’re about to buy a car. And for you to do that, you’d have to consider ownership costs and insurance. But these are not the only two factors that can influence your interest rate.
That is because, interest rates, more often than not, are usually anchored on your credit score. Individuals who have the best rates have a high credit score. And the poorer your score, the more money you’d have to fork over as interest. The cost of your interest rate will determine whether you can afford the monthly payments for your car loan. That’s the reason it’s essential to know what type of rates to expect before you entertain the idea of going car shopping.
Your credit score is compiled by Credit Bureaus, who use your financial transactions to determine your borrowing history. If you have a low rating, that means you have a higher chance of defaulting on your loans than an individual with a higher score. And this means the lender will consider you a “high risk” candidate for a car loan.
Most traditional lenders in Canada are reluctant to advance money to high-risk applicants. So they try to drive them away with higher interest rates. It now becomes a question of “how much do you want it? If you want it so bad, then you’d have to pay more. The lender also considers the higher interest rate as the cost of doing business with an individual who has a high likelihood of default.
If your credit score is 700+ and above, you’re in the safe zone. When you apply for a vehicle loan, you can be sure to receive rates within the 3 – 4% range. Some manufactures or dealers even go out on a limb to offer 0% interest rates for customers with an excellent credit score. That means the customer pays the principle without taking on the cost of borrowing the funds.
Further down the line, the picture is a bit different if you want to buy a used vehicle. One of the lowest rates you can get on a second-hand car hovers around 4.9%. The average price for an individual with a good credit score is 3% – 6%. Expect to receive an interest rate of 6.5% – 15.9% if you have a terrible score. Despite the above, you shouldn’t give up hope because there are lenders who specialize in giving car loans to customers with bad credit.
But that’s not all. The loan term of your purchase also has a significant effect on your rate. For some lenders, you’d receive a lower price if you pay your monthly rates for a longer-term. On paper, your rates may seem small, but when you look at the total cost over time, you’d have paid more money in interest rates. But this method does not hold for all lenders. Some conservative lenders tend to charge a higher interest because longer loan terms are considered to be riskier.
The type of car and the model also play a part in how much you’d be paying monthly. The fact is, all vehicles are not created equal. Some have better resale value than others. Because of this, two cars of similar price can have different rates.
And finally, your down payment. Are you putting a drop into the bucket or a large chunk? There’s something called a loan-to-value ratio that the lender calculates by dividing your loan debt by the value of the car after depreciation.
The formula for LTV = Loan Amount/ Car Value
That means if you borrow C$50,000 to buy a C$50,000 vehicle, you’d have a 100% LTV. If you collect C$50,000 to buy a car worth $25,000, your LTV will be 200%.
The reason lenders calculate the LTV when you want to buy a vehicle is to protect themselves. The collateral for your loan is often the product you want to finance. So the lender ensures it’s not taking a loss when it gives you money by setting a maximum LTV. And this is where your down payment plays a critical role. The best way to reduce the LTV on your loan is by simply taking less money. And the only way you can take less is by down-paying more.
There’s a lot more to interest rates than meets the eye. Lenders have different criteria, and customers have different circumstances. The best way to get the lowest rates is to consult several lenders before settling on a preference. In addition to that, you can also improve your credit score or save up for a larger down payment.