Understanding Auto Loan Interest Rates

February 25th, 2016 by

The auto loan interest rate works similarly at buy here pay here Cincinnati dealerships, it’s just a little higher. That means, whether you are shopping at a new, used, or independent car dealership, the concept is the same. It all starts with the financing, which is getting approved for a loan. Then, they take a look at various factors to calculate the interest rate on your auto loan.

This should provide you with a basic understanding on how auto loans work. Keep in mind, this isn’t a way to give you an exact calculation for an interest rate; it’s simply a way to understand what factors contribute to your interest rate.

Financing

Financing itself is a broad term, so what does it mean for you? In this case, it’s when a borrower (you) takes out a loan in order to pay for something that costs more than they can pay for at one time. For you, it would be a car. In order to get approved, your credit history/score gets checked. If you have a low credit score, chances are you won’t get approved from a bank or mainstream dealership; which is where BHPH and bad credit dealerships come into play.

That’s the basis of financing, and it’s quite simple. If you get approved for your car loan, then you get X amount of dollars, and are expected to pay it back in installments over a certain period of time.

How Interest Rates are Calculated

These installments come with an interest rate, and it’s important to know how these are calculated. The factors that make up the interest rate are credit history, debt-to-income ratio, and 2 different types of interest rates. So you aren’t wondering how interest rates make up the interest rate, we will cover that first. The two types of rates used are the simple interest rate and the compound interest rate. The simple interest rate is calculated using only the amount of the principle owed, and a compound rate uses both the amount owed AND the interest rate owed. Yes, you are paying interest on the interest.

As confusing as that one was, the next two aren’t so hard to understand. Your credit history is probably the biggest factor in determining your interest rate, and a higher score/better history translates into a lower interest rate. Because a higher score tells the lender you are responsible enough to pay off the loan, so you won’t get whacked with such a high interest rate.

The debt to income ratio is how much your gross monthly income goes towards paying other bills like housing and food. If your ratio isn’t satisfactory, chances are your interest rate will get bumped up a bit. This is because you are taking on another type of financial responsibility that will add to your debt-to-income ratio.

This is just a basic understanding of auto loan interest rates, but it’s enough to get you started. The more you know about your interest rate and car loans, the better off you will be when applying for one. That old adage “knowledge is power” has never been more true when it comes to car shopping.