Interest rates vary by industry. Home loans have interest rates between 2.5-5% or more. Many department stores offer introductory rates with zero interest for the first six months, up to several years. You’ll find rates fall anywhere from zero up to 15% or more in the auto industry depending on whether you’re buying new or used.
So what qualifies as a reasonable interest rate on a used car? This simple question has a more complicated answer than you may have thought. Let’s take a closer look at what interest rates are, how they get set, and how you qualify for the lowest possible rate.
What Is an Interest Rate?
Lenders define their interest rates as the amount charged a person to borrow money per period (usually a year) and calculated as a proportion of the total amount borrowed. Lenders express interest rates as a percentage of the entire loan. Over the life of a loan, the total amount of interest paid depends upon the total amount borrowed, the interest rate itself, the compounding frequency, and the length of the loan.
In simpler terms, interest equates to the price you pay for the privilege of using someone else’s money. You aren’t always on the paying side. You may have a savings account or IRA that earns interest for you. That’s the fee you earn from the bank for allowing them to hold your money.
How Does an Interest Rate Work?
A simple interest loan formula looks like this: Amount Borrowed x [1 + (Interest Rate x Loan Length in Years)].
So if you borrow $20,000 at an interest rate of 5% and a term of 5 years solving the formula looks like this:
- 20,000 x [1+(.05×5)}
- 20,000 x (1+.25)
- 20,000 x 1.25 = 25,000
Over the life of this loan example, you’ll pay $5,000 in interest. Now, if you have an interest rate of 2.5% instead of 5%, the same loan will cost you $2,500 in interest. Now you can understand how impactful an interest rate can be to the cost of a loan.
Annual Percentage Rate vs. Interest Rate?
Annual percentage rates (APR) include fees associated with the loan. The inclusion of these fees raises the APR, only slightly in most cases than the actual base interest rate. APRs provide a way to measure the overall loan cost. In the auto industry, these fees can include sales tax, paperwork charges, and title costs. The formula to calculate the APR looks like this:
- Add the total interest paid over the life of the loan to the total fees.
- Divide that total by the amount borrowed.
- Divide that number by the number of days in the loan term.
- Now multiply this number by 365.
- Multiply the result by 100.
Using the above 5% loan with $1,000 in fees the solve looks like this:
- 5,000 + 1,000 = 6,000
- 6,000 / 20,000 = .3
- .3 / 1,825 = .00016438
- .00016438 x 365 = .06
- .06 x 100 = 6
The APR for this loan comes to 6%, slightly higher than the actual interest rate of 5%. When shopping for loans, it’s essential to look at both the interest rate and the APR. The APR gives you the total cost of your loan, including fees.
What Affects My Interest Rate?
Many things affect your interest rate, but the number one factor will always be your credit score. The better or higher your credit score, the better or the lower rate you will qualify for from the credit companies.
Credit scores get separated into five categories: Super Prime, Prime, Non Prime, Sub Prime, and Deep Sub Prime. If you have a Super Prime credit score of 720 or higher, you will qualify for the best interest rates. Conversely, if you have a Deep Sub Prime credit score of 579 or lower, your interest rate will be much higher, or you might not even get approval for a loan.
It’s important to understand that when you see a loan rate advertised, that rate correlates to Super Prime credit scores. The length or term of the loan also impacts your interest rate. The shorter the term, the lower the rate becomes.
How Can I Get a Better Interest Rate?
The first step would be to check your credit report. You can get a free credit report every year, and if you don’t already check this report, you should start now. Examine your report for discrepancies that happen more often than you might expect. You can take steps with the credit reporting agencies to correct these discrepancies and improve your credit score.
Your debt to income ratio impacts your creditworthiness too. This ratio reflects the amount you owe versus the amount you earn annually. You might be better off waiting a year and paying down your debt before taking on a used car loan if you can.
Paying your fees upfront rather than financing them will lower your APR. If you can, negotiate these fees down and pull them out of the loan to save money in the long run.
Average Rates on New and Used Car Loans
Interest rates fluctuate daily as a result of market influences in our economy. You should check the current rates with your bank or credit union, local car dealerships, and national credit institutions to get real-time rates when you’re ready to purchase a vehicle.
You can expect an interest rate as low as 2% on a new car loan and 3-5% on a used car loan from many lenders if you have a Super Prime credit score. These rates climb as your credit score drops, so keeping your credit score high will help you secure the best possible rate.
Many car dealerships offer in-house financing, meaning the dealership loans you the money. This in-house financing allows them to write loans at whatever rates they choose, but you can expect them to stay close to market averages.
Apply for Used Car Loans Online in Grand Forks
At Rydell Outlet Center, we understand the need to stay within your budget. Our finance department are experts at identifying the best loans to fit your budget. We have relationships with local and national lenders that we leverage on your behalf. You’ll always get a fair and honest price on a used car from us, and our comfortable loan process will have you approved without worry.
We encourage you to take advantage of our convenient online pre-approval application. Or, contact us to speak with one of our finance experts to discuss the different options available to you.
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