Down Payment or Interest Rate: Which is More Important in a Car Loan?

If you are wondering whether a down payment or an interest rate is more important, look no further. While a down payment can affect the overall amount of financing needed, the interest rate will determine your monthly payment. Therefore, interest rate is the most important factor in obtaining a car loan.

Cars and other autos are large purchases, sometimes reaching into the hundreds of thousands of dollars. For the average buyer this type of purchase is second only to the purchase and financing of a home, where interest rate is also a very important factor. Most auto purchasers do not have the available cash to purchase their cars outright. This fact is the main reason the auto loan industry was created, and also the reason so many banks and credit unions offer auto loans.

In today's market, most auto dealers offer their own financing in addition to any bank financing the buyer may bring to the table. With the proliferation of "sign and drive" deals, very few auto companies require down payments any longer. They are less concerned about how much money you are bringing to the table and more concerned about your credit rating. Your credit rating, which gives them an indication of whether you're likely to pay their loan on time or not. Credit rating will also determine your interest rate, which in turn determines how much you pay on a monthly basis. The lower the credit rating the higher the interest rate. The higher the interest rate the higher the monthly car payment.

Your credit rating can swing your interest rate as much as 5% or more. An applicant with a FICO credit score of 800 or better may be able to obtain low financing, say 3.9% for 60 months, while another applicant with a FICO credit score of 500 would likely obtain a rate of 9.9% interest on their car loan. If both these applicants were financing $10,000, their monthly car payments would be $152.55 and $211.97 respectively. The borrower with the better interest rate is able to save $28.26 per month over 60 months for a total savings of $3,565.20. In the end, the borrower with the higher interest rate paid 35% more for the car than did the borrower with the lower interest rate.

Conversely, the low FICO borrower would have to make a down payment of $2,800 just to get the same monthly payment as the borrower with the better credit rating. The difference is that the applicant with the better credit didn't have to sacrifice their cash to do so.

If you know how much you can afford to pay for a car loan on a monthly basis you can figure out the interest rate you would need over a certain period of time to be able to cover the expense. This can be done with a simple car loan calculator which can be found online or by calling your local dealer. If the interest rate or monthly payment are too high for you to afford, you have the option of adding a down payment which can then lower your overall amount financed. If the financed amount comes down, your monthly payment will also come down.

 

 


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