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How is the interest on a car loan determined?

Apr 04 2016 07:57

A Fin24 user wants to know what determines her interest rate on her car loan as she plans to trade-in her car and apply for refinancing. She writes:

I want to buy another car and trade in my current car. I would like to know what determines my interest rate on my car loan. Can the dealerships charge me high interest rate instead of a realistic interest? Which is better to buy with - a balloon payment or not?

Rudolf Mahoney from Wesbank advises:

Interest rates on car loans are personalised, with the final rate being based on your current risk profile to the bank. When you apply for finance at the dealership, the finance and insurance (F&I) representative submits your finance application to all banks. You are able to choose the finance offer and interest rate that suits your budget. It is also very important to understand that it is the banks and not the dealership that ultimately decide on your interest rate.

Your credit history and credit score are used to determine whether you are in a position to easily afford the monthly repayments on a new car loan. Should it be determined that you cannot afford the loan, you may not be granted credit. However, if your profile shows that you have stability – you own property, you have savings, and you are married – you pose less of a risk to the bank, and your interest rate may be lower.

Additionally, your history is evaluated to see whether you have previously paid all your accounts on time. In instances where you have missed payments, but you have since paid all outstanding debt, you may be given a higher interest rate. The bank will consider you as a financial risk, as there is a chance you will not pay your debt on time, or at all.

READ: A few common misconceptions when buying a car

If you are trading in an existing vehicle and you have a clean credit record, these factors could count in your favour. If your current vehicle is paid off, its trade-in price will be used as a deposit on your new vehicle. Paying a large deposit on your next car also shows financial responsibility.

In both cases you end up borrowing less money, which presents less of a risk to the bank – and could thus result in a lower interest rate.

Balloon payments are large payments that have to be made at the end of the vehicle finance period. For example, when you finance a vehicle of R100 000 and use a 10% balloon payment, you will pay back R90 000 over the contract period, and make a final payment of R10 000.

Balloon payments can be used to help lower the monthly instalment, but should only be considered if absolutely necessary. Buyers sometimes make use of balloon payments, but forget about the final payment. This sometimes requires either selling the car, to settle the outstanding amount, or taking out a new loan to cover the balloon payment. Of course, this will incur more interest charges.

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vehicle finance  |  money  |  money clinic
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