Interest rates can have a profound impact on the amount you'll ultimately pay on your car loan. A few percentage points can mean a change in thousands of dollars over the course of the car loan. If you are new to the car buying process, here is some information to help you understand what interest rates are, and why they can go up or down.
What is an interest rate?
The best way to define interest is to consider it a fee which is paid for the privilege to borrow money. For example, let's say that you need a car loan in the amount of $10,000. The lender approves your loan, and charges a rate of 7% interest. This 7% is the fee that must be paid for the privilege to borrow money. In this way, banks make money on the loans that they offer.
Why interest rates can go up?
There are many reasons why interest rates can increase. Choosing a shorter length of loan is one reason. If you opt to go with a 36-month loan rather than a 48 month loan, the lender might opt to charge a higher interest rate in order to make the loan more profitable for them. How you handle stewardship of the loan is another reason the rate can increase. If you miss payments, this too can cause the interest rate to increase, assuming that the car isn't repossessed. Having a bad credit score can also cause your interest rate to be higher than usual.
Why interest rates go down?
Just as being neglectful of your credit can cause the rate to rise, keeping your credit good can be a wonderful bargaining chip in getting your interest rate lowered. If you started out at a high interest rate, but make payments on time, you may be able to refinance the loan with a different lender and get a lower rate.
Car loans with zero interest might seem like a no-brainer, but there are a couple things to keep in mind. First, zero interest loans are almost always only offered at the dealer, and then on new cars only. This is because the car manufacturer will use zero interest as a marketing strategy to help keep their new car inventory low. Secondly, if you opt for a zero interest loan, there will be less room for haggling on the price with the dealer. You can expect to purchase the car at or close to MSRP if you accept a zero interest loan. Finally, zero interest might only be temporary, for maybe the first year or two. After that you might be expected to pay interest on the loan.
Hopefully this information has helped you understand a little better what interest is, and why it is so important to both buyers and lenders.