How Does The Prime Interest Rate Affect My Car Loan?
All About Credit
Credit is simply impossible to avoid these days. No matter what the major purchases are that we judge our lives by your credit score is likely to play a huge part in every single one of them. From a satellite television all the way up to becoming a homeowner for the first time, odds are there are going to be purchases you’ll want to make you simply don’t have the money to pay for up front. If that’s the case, don’t worry—it’s totally normal, and by looking at the size of some of the multinational credit companies, you’ll be able to see that it’s in fact even built in to the way society is structured.
Your credit score is similarly unavoidable as you try to build a financial life for yourself. Consisting of just three digits, it’s a mathematical representation of how likely you are to pay back the money that the lender is giving you. Think about it from the lender’s point of view: you’re effectively offering another human being something for free (or almost free), on the condition that as time goes pay they’ll pay you back for the value of the item. It sounds a little crazy, right? The fact that it is a little crazy is a major reason for the significance credit scores play in all of our lives these days. Whether it’s a car loan or a mortgage on an entire house, credit is crucial.
What Risk Has To Do With It
The way the lender compensates himself for the risk involved in essentially handing somebody else something for free is by the rate of the loan he arranges for the buyer. It’s important to note a distinction between the rest of the loan and the interest rates involved.
Money you pay towards interest on a loan does not go towards the value of the item itself—that value is completely accounted for by the monthly instalments, not including interest. Interest rates have been calculated by incredibly talented mathematicians to correspond with your credit score and ensure that the lender is getting enough protection for the risk he’s bringing on to himself by securing you for a loan in the first place.
Just as your credit score is a mathematical figure that accounts for how good you’ve been, historically, at paying back the money you borrowed, so too are interest rates mathematical figures that correspond with just how reliable you are as somebody to lend money to. Car loans are no different to loans you’ll take out on expensive gadgets, which are themselves no different to loans you’ll take out on property. It all comes down to your history, and how well your history can predict how you’ll behave with this next car loan you’re attempting to secure.
The better your credit score is, the lower your interest rates will be. That means that for a car loan, to get the absolute lowest interest rates possible (which themselves correspond with a lower overall loan value that you’ll have to pay) you need your credit to be firmly in the prime range—ideally even superprime, but there are few among us indeed who can claim to have such a near-perfect credit score.
The Good Thing About Shorter-Term Loans
As well as securing lower interest rates for yourself, you’ll also be able to get a shorter-term loan. If you think about this from the lender’s point of view, it makes sense too. If they’re offering money to an incredibly reliable person with an immaculate history of paying back financial obligations, why wouldn’t they want to get it all out of the way as quickly as possible? There’s little to no risk involved, mathematically speaking—certainly there’s significantly less risk than is represented by somebody with a less than optimal credit score—and so they have no interest in denying you possession of the item any longer than they absolutely have to.
Conversely, if your score is a little lower than what it should be, it’s unlikely you’ll be able to get yourself a shorter-term deal on the car loan you’re intent on securing. The longer the loan goes on for, the more likely you are to need to pay money for upkeep on maintenance: and if your car breaks down before the loan is finished, you’re essentially paying to maintain something you don’t even own. This isn’t a great scenario, and it’s something all of us want to avoid, which is why it’s best to keep your credit score as close to the prime category as possible.
In the following paragraphs below, we’re going to discuss just how much a prime interest rate is going to affect the overall state of your car loan, and why it needs to be that way. We’ll also talk about the incredibly high rates of interest you may incur if your credit score is a lot worse than it should be, as a means of illustrating the contrast between different kinds of buyer from the lender’s point of view.
But that’s enough preamble and background information. Let’s get right to the heart of the matter. Here is exactly how much the prime interest rate is going to affect your car loan, laid out plain and simple, once and for all.
How Does The Prime Interest Rate Affect My Car Loan?
Let’s briefly talk about what it means to be in the category of buyer that is classed by actuaries and lenders alike as ‘prime’. There are a few different kinds of credit score categories, each of which is approximately delineated by a certain range of scores. While these terms aren’t set in stone and indeed vary widely from one firm to another, just as they do from one lender to another, the general principle is the same and it’s certainly good to keep a rough figure in mind as a rule of thumb, for your confidence in the arena as much as for any financial implications. We’ll briefly sketch out just what exactly these categories are, starting from the bottom, as a means to illustrate how helpful it’s going to be for your car loan if you’re able to secure a prime interest rate.
Deep Subprime is the category that takes into account anybody with a credit score between 300 and 500. This indicates a seriously risky investment for the lender, and comes about as a result of either identity theft, filing for bankruptcy, or serious financial irresponsibility.
Subprime encompasses scores between 501 to 600, and while they’re not as poorly dealt with as Deep Subprime buyers, the interest rates they’ll be able to secure on their car loans aren’t much better.
Nonprime can be considered the middle level of the whole buyers list. With a credit score ranging from 601 to 660, this is typically where people just starting out on their credit journey will find themselves. While it’s not terrible, you can do better.
There’s some debate as to whether it makes sense to separate the credit scores from 661 to 850 into two different categories or just one. For the sake of this article, we’ll label that whole range as Prime, and ignore for the moment the top-tier category of Superprime (which is often considered as counting any scores from between 781 and 850).
So now that we have a rough idea of how buyers are split up in the minds of the lenders, let’s take a closer look at what having a Prime credit score will actually concretely do for you in terms of the conditions on the car loan you’re hoping to secure.
The average interest rates received by Deep Subprime buyers was 14% for new car loans, and almost 20% for used car loans (19.81%, to be exact). If you think about it, that means that these buyers were so risky that the lenders needed to demand an entire fifth of the value of the car just to ensure that they weren’t taking on too much risk.
This is staggering, and should be enough to scare anybody away from ever allowing their credit to get that low (granted, we don’t always have a choice in these matters, but if you find yourself behaving irresponsibly in a financial sense, do take steps now to correct those unhelpful behaviours before they become compulsive, because they’re only going to hurt you in the long run and it’ll never be easier to change them than it is right now.
Let’s compare those rates with the average rates received by Nonprime buyers, who, as we recall, are effectively the middle tier of all customers looking to secure a car loan. They received an average interest rate of 7.05% on new car loans and 10.44% on used car loans.
(N.B.: Used car loans incur higher interest rates because they represent more of a risk, owing to the fact that they’ve already been used some and are significantly more likely to require maintenance payments throughout the duration of the loan than similarly-priced new cars.)
While this is a lot better than what’s on offer for Deep Subprime buyers trying to get themselves a car loan, it’s still a little steep, in accordance with the fact that Nonprime buyers are still considered somewhat risky investments for lenders looking to give them money.
Now that we’ve got a rough idea of how the rest of the credit score ranges will fare when they’re trying to get a car loan, let’s take a look at what happens if you’re going to get a Prime interest rate on your car loan.
Averaging The Prime Interest Rate
Averaging out the top two categories into a single prime figure gives us an approximate interest rate of 3.695% on a new car loan, and a rate of 4.815% interest on a used car loan. The difference between this top tier of buyers and the more standard credit scores is start. No prime buyer should ever need to pay an interest rate of much more than 5%.
Remember that while Deep Subprime buyers are required to pay an entire fifth of the car’s value just to ensure that the liner doesn’t take on any unnecessary risk, Prime buyers will almost never need to pay more than a twentieth of the car’s value to do the same. This symmetry between the two categories is the perfect way to highlight just how much of a plus it’s going to be for you if you can secure yourself a prime interest rate on a car loan.
Of course, the actual figures are going to vary, depending mostly on the make of car you’re trying to buy and the deal you can get out of the salesman who’s trying to get your signature on the dotted line. But dotted lines aside, the bottom line of the topic is clear: prime interest rates heavily reward those who have proven themselves to be historically reliable when it comes to taking on financial obligations, and the benefits these buyers will be able to reap compared with other tiers of credit scores are significant, and unlikely to change anytime soon.
Don’t forget that we here at Autoloan.ca consider every single application made to us for a loan, independent of the credit score involved. Give us a call and ask us how we can help sort out a car loan for your specific situation.