Buying a car is one of life’s biggest decisions one has to make. After comparing the make or model, the next thing to consider is the cost and whether you can pay for it. If you don’t have enough to buy one, the next thing to consider is a car loan.
Car loans attract a certain percentage of interest, so before you sign the contract, it’s essential to understand the interest charged on the loan amount and how you will repay the car loan. This guide will help you understand car loan interest rates and how to calculate car loan payments.
What is the Interest Rate
An interest rate is a basic rate you pay to borrow money from a lender when financing a car purchase. Interest is added to your monthly loan payment and calculated based on your remaining loan balance.
Interest rates and annual percentage rates (APR) are the two commonly used ways to express the cost of borrowing money from a financial institution.
It’s important to understand that interest rates vary widely, so check the current car loan rates before going to the car dealer. You can opt for pre-approval from a financial institution before visiting car dealerships.
How are Interest Rates Calculated?
Lenders use two ways to calculate interest rates on auto loans – simple or precomputed interest. An auto loan with simple interest is calculated based on your loan balance on the day of your payment. With simple interest, the amount you pay changes monthly. On the other hand, with precomputed, the interest is calculated based on your loan amount, and the interest you pay remains the same every month.
Most car loans are simple interest loans, meaning interest is amortized and front-loaded. With amortized loans, a part of your monthly payments goes to the principal amount and the other part to the interest charges. A simple interest loan is the best option if you are planning to pay off your loan faster and pay lesser interest.
Factors Affecting Interest Rate on Your Car Loan
Several factors impact your auto loan interest rate, and understanding them will help you make a wise decision:
Credit Score: Your credit score helps a lender check your ability to repay the loan. Your loan interest will likely be lower with a good credit score.
Down Payment: This is the amount of money you pay upfront, depending on the cost of your car. The amount you pay as a downpayment can affect your interest rate. Lenders may charge higher rates if the down payment is small.
Loan Term: Interest rates vary depending on the loan term. Longer loan terms attract higher interest rates.
Used or New Car: Interest rates on loans for a used or new car differ significantly. Loans on used cars have higher interest rates than those for a new car.
Lender Type: Consider an auto loan from a financial institution with more attractive rates and go for the one with lower interest rates.
How Can You Pay Less Interest on Your Car Loan?
Interest charges can greatly increase the amount you repay by thousands of dollars. Fortunately, there are ways that can help you avoid overpaying interest. These include:
Shopping around: Shop around for attractive offers on financing.
Shorter loan term: Choose a shorter repayment term that will lower the total interest you will have to pay.
Early repayment: You can reduce interest charges by paying off the loan balance early.
Improve your credit score: The higher the credit score, the better rates you get.
Refinance: If your auto loan has a high-interest rate and the rates drop down the road or your credit score improves, you may look for ways to refinance it.
If you can’t get a regular car loan in Canada, there are other financing options you can consider. You may finance with a credit card or through a personal loan. A personal loan will give you a better interest rate if your credit score is good.
