What Does the Interest Rate on a Car Mean?
Many cars, particularly new ones, which can command a price in the tens of thousands of dollars, are purchased not with cash but with the aid of a loan. The borrower purchasing the car usually repays the loan in monthly installments, to which the lender will add a preset rate of interest.
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Features
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Loans to purchase vehicles are generally offered either by the company selling the car or from another financial institution, such as a bank or credit union. Like a mortgage or business loan, the issuer of the loan will put up the cost of the purchase, receiving compensation in the form of interest on the loan.
Types
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Auto loans vary according to the length of loan and the rate of interest. According to BankRate.com, a typical car loan will last between 24 and 60 months, some dealers will offer loans that last up to 84 months. However, longer loans generally command a higher rate of interest. Interest rates on loans are either fixed-rate loans or adjustable rate loans, which adjust over time, correlated to the prevailing interest rates. In some cases, the interest on the loan is compounded; in other cases, it is not.
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Significance
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Even a small difference in the interest rate of a car loan can mean the difference between thousands of dollars over the life of the loan. According to BCS Alliance, a difference of 1.55 percent on the interest rate for a 60-month loan for a $20,000 car works out to a difference of almost $1,000.
Expert Insight
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According to BankRate.com, new cars generally receive lower rates of interest than used cars and also receive longer lengths for their loans. This can mean a buyer can actually end up paying more for a used car with a lower sticker price than for a new car with a higher price because the buyer is paying more on interest. With most loans, however, the borrower will spend a period of time early in the loan "underwater," meaning the borrower owes more on the car than it is currently worth.
Warning
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If the payments on the car become unaffordable -- which can happen due to a change in the borrower's financial situation or, in the case of an adjustable rate loan, a spike in interest rates -- and a borrower begins to miss payments, he may be at risk of losing the car. If the loan becomes delinquent, the issuer may repossess the car; generally, he will not be required to refund any money that the borrower has paid on the loan.
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References
- Photo Credit yellow car, a honda japanese sport car model image by alma_sacra from Fotolia.com
