If you want to shop for a car, there’s a lot to consider in the price alone, as there’s more to the “sticker price” than meets the eye. You need to consider the down payment, which is generally advised to be about 20% of the value of the car and then you need to decide for how long you want to make payments.
The underlying factor in all of this is your annual percentage rate, or APR, which is the cost of borrowing money for your car (interest). This is amortized monthly, on the principle, or total remaining, loan amount.
APR, or annual interest rate, comes down to your credit score. The higher your credit score, the lower your interest rate will be. A popular credit score software that dealers or lenders may consider is FICO. If your FICO score comes out to anything above 720, it’s considered “Prime”, which could net you an average interest rate of 3.6%.
If your credit score is exceptionally low, between 500-600, you may qualify for an average rate of 15%, which is a massive increase. In other words, if you pay your bills on time and to completion consistently, you probably qualify for a low-interest rate loan.
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A car loan is a closed-end, fixed rate loan based on simple interest which is calculated based on the remaining loan amount, as opposed to compound interest which considers the remaining loan amount adding the interest on top. However, car loans use something called amortization, which is when your payments go more toward paying off the interest at first but later on will go toward the principle loan.
A good way to mitigate the impact of APR is to make more than one payment, or a larger payment than originally intended, per month. This effectively lowers the amount that the interest payment is based on and thus can ensure you pay off your loan faster while saving money. Be careful though, as some lenders will see your double payment and then not charge you for a month.
The best ways to guarantee the lowest interest rate possible is to make sure your credit is as high as you can make it, pay a bigger down payment (more than 20%) as that will lower your loan amount and therefore how much interest you’re going to pay and make sure you’re getting the best price possible. Dealerships at the end of the month will often be more flexible with prices, so it’s a good idea to wait until then and get several quotes from other dealerships, and use those quotes to negotiate for better deals.
APR is something to be aware of, as it’s something you can’t really get away from in the first place. So understanding how it works and what you can do about it is paramount.
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