Loaning someone money bears the risk of you not getting paid back. Interest rates are kind of a “safety switch” for lenders when they loan a certain borrower money. The greater the risk the borrower represent, the higher the interest rate will be.
There are a lot of components that come into consideration in deciding the amount of interest rate that a borrower will have to pay. Below is a simple walk through of some factors that affect an interest rate.
Modern monetary policy is the way for nation-states to maintain currency stability by. This can be achieved by balancing economic growth and inflation. The Governing Council of the Bank of Canada sets an overnight rate of lending or what they call Key Interest Rate. It establishes daily (overnight) lending rate between financial institutions. This rate has an inflation control target of 1 to 3 percent which is renewed every five years by the federal government.
Economists agree that a 2% inflation is the optimum rate in order to balance encouragement of economic while avoiding the perils of inflation. When the economy is significantly improving consequently also increasing inflation, the Bank of Canada raises its interest rates in order to make borrowing money expensive thus reducing economic growth and stemming inflation. On the other hand, when the economy is weak, the Bank can lower interest rates in order to make borrowing money cheaper.
This is vital because the Key Interest Rate sets the tone for lenders. If the cost for lenders to borrow money is expensive, the less they can charge individual borrowers for car loans and other loan products. In short, the Bank of Canada – guided by national and international economic factors – determines the tone of fluctuation.
Interest rates do not include non-principal payments on an auto loan which can include documentation fees, title fees, warrant charges and other fees. The more complete figure is the annual percentage rate or APR. An APR includes all finance charges associated with the loan.
If you want to get the whole picture, ask your dealer for the APR to gain full insight of what you are about to commit to.
Your credit history is influences your credit score. A credit score is a numerical value that pertains to your credit history providing lenders information regarding your creditworthiness. Credit scores range from 300 to 900 and this is determined by three major credit-reporting agencies namely; Equifax, Experian and TransUnion.
Credit scores are basically based on the borrower’s debt-to-income ratio and bill-payment history. There is a strong correlation between your credit score and the interest rate you are expected to pay. A higher score means a lower rate especially for those with exceptional scores (i.e. 700 or higher) giving them the pleasure of paying no interest at all (0.00%)!
The same cannot be said for those with lower scores since a low score would mean high interest. In fact, scores below 500 poses the risk of not getting an approval from your lender/dealer. Borrowers with low credit scores can also benefit from a cosigner on their loan. A cosigner is a person that is usually more financially stable and agrees to pay your remaining debt if in case you can no longer settle your debt. This added assurance for the lender can result in lower interest rates for the borrower and help with the approval.
If you want to improve your credit score, take a look at your credit mix. Lenders like to see revolving credits from credit cards and installment credits (i.e. home mortgage). Repayment of past loans and active, up-to-date credit accounts secure your chances attaining a lower interest rate.
Auto loans longer than 60 months usually take on increased interest rates. The reason for this is because of the increased risk that the lender is taking on your credibility as a borrower and ability to repay what you owe over a longer period of time.
Meanwhile, a shorter loan duration, regardless of the constant interest rate, means lesser money dedicated to paying the total interest. You’ll save money in the longer run! However this will also mean higher monthly payments so if you have the budget, this is a good strategy.
To put it simply, if you want the lowest possible interest rate, pick a shorter loan term. Just keep in mind your monthly obligations when choosing this loan term.
Placing a down payment is another way for you to avoid being buried in interest payments. How? Your down payment shows the lender that you are committed to repaying back what you owe. To add, lenders are also risking less money if you place a down payment giving them a sense of security.
Whether paying up-front in cash or trading-in your old car as down payment, it will always put you in a better situation compared to those who opted not to. Of course, a higher down payment would result to more savings for you since the principal of the loan is also reduced.
Not all variables are covered by your credit history, loan duration and down payment. Other financial factors are also taken into consideration by lenders.
One example is your current job status. Lenders are looking for stable earners with stable employment history (at least two years). Having a stable job is important because lenders must project your creditworthiness in the present and several years into the future. Providing recent pay stubs and verification from your employer may be needed by your lender.
On the other hand, if you are new to your job, you can remedy this limited work history by paying a large down payment. This will increase your chances of securing the loan. Similarly, looking for a vehicle that is within your budget will make a lender more confident and may possibly give you a lower interest rate. Unlike banks, dealerships are more motivated in selling you a car since they too can benefit from your purchase.
Many variables come into play in a lender’s decision regarding interest rates that he can offer. A multitude of variables give you a wider array of options in order to get an interest rate that is well-suited to your budget.
Want to know your possible interest rates? Click here and fill out our very simple application form. New Car Canada can provide you the best possible interest rates.