A recent article in an automotive trade magazine preached the benefits of teaching financial literacy to younger members of society. The purpose, of course, is to enable the younger population to handle the financial stresses that they will encounter as they get older. Quite simply, most adolescents (and many adults) have no clear idea how to balance a checkbook, develop a good credit rating, or successfully manage credit. One of the areas that many customers question is why the interest rate on a particular vehicle loan is at a certain level. Expectations of low interest rates are often quashed when customers learn how financial institution personnel and computers determine interest rate levels.
Many variables affect the interest rate a particular lender is willing give to a customer. The first and foremost consideration is the customer’s credit or “beacon” score. Credit score has been a subject of many of my previous articles and without rehashing all of the particulars, customers applying for credit need to be aware of their true credit score. A credit score is determined by multiple factors but most importantly the timeliness with which bills are paid. Pay them late and your score goes down. Don’t pay them at all and the score plummets. Pay them on time while carrying a lot of credit and the score remains marginal.
The only place to receive your true credit score is from one of the scoring agencies like Transunion or Equifax. Sites like “freecreditreport.com” use their own scoring system and often inflate scores and mislead customers to sell one of their products. Accordingly, the best thing to do is to start by getting your correct information from a reputable source.
When buying a car, the decision to buy new or used often affects the interest rate. While a customer may save money on the price of a pre-owned vehicle, interest rates are usually higher because the rates are not supported by the manufacturer’s “captive” finance companies. The only exception is with manufacturer’s “certified pre-owned” programs. These vehicles are often supported by special interest rates from the manufacturers as an incentive to attract brand loyalty. The goal is to get a buyer in the seat of one of their products and the attractant is the special interest rate and warranty coverage attached to the make and model of vehicle. To qualify for these rates, customers must possess a better than average credit score. A lower credit score usually translates into a higher interest rate.
Multiple other factors affect may affect your the interest rate. Banks and lenders like to see customers put money down on the purchase. The days of “zero down” are not gone, but are slowly becoming extinct. Down payments are attractive because the purchaser has a little of their own money in the game as a sort of “good faith” in the purchase. When a customer advances money in the form of a down payment, the chances of an early default on the loan are reduced. This makes the customer a better credit risk, and in turn, a better candidate for a lower rate.
Credit score alone is not determinative of the rate that a bank or lender will offer. Many customers have good credit scores because of consistent payment history. However, a closer look at the credit bureau will reveal the customer is barely hanging on. In some circumstances, only minimum payments are made to lenders and the debt-to-income ratio is high. The debt-to-income ratio can be defined as a calculation that analyzes how much of an individual’s monthly income is used for payment of debt. A lot of debt with a lot of income still makes the ratio high and the customer becomes more of a credit risk resulting in a higher interest rate. Additionally, the length a credit file has been established has a bearing on the interest rate. A person with good credit but minimal credit history will probably have a higher interest rate. This occurs because the lender cannot make an accurate assessment of risk based on the limited credit information in the file.
I was able to write down about twenty-five other factors that were considerations for interest rate levels before writing this article. Of course, most of this is determined from an algorithm in a computer database that crunches the individual factors and then returns a proposed loan amount and interest rate. Human credit analysts still assist and make individual determinations. Because of space limitations, I cannot include them all but other considerations should be noted. Some other factors that the computers and the analysts consider will be:
- Accounts being individual or joint;
- Total monthly and household income;
- Current employment status and length of time with an employer;
- Educational level;
- The length or term of the loan;
- Previous car credit and length of car credit;
- Ownership or rental of residence;
- Length of time the credit file has been established.
All of the items that are determinative of your interest rate may also affect your credit score. Educating yourself and being financially literate will assist you in paying down debt and raising your credit score. Then the next time you apply for a car loan you can be one of the people who falls into the category of “a well qualified buyer” that is always referred to in the hastily spoken disclaimer at the end of the advertisement.