Buying a new car is likely one of the largest purchases you will ever make, second only to a house.
Unless you have thousands of dollars on hand, you’ll have to take out a loan to pay for that new car. And much like obtaining a good mortgage for a house, you’ll need a solid credit score and financial history to get the lowest interest rates on auto loans.
“If you want to get good financing, plan ahead,” says Mark La Spisa, president of Vermillion Financial Advisors and a member of the Financial Planning Association. “Do not buy new furniture on credit or apply for new credit cards.”
Banks, credit unions and other lenders will base your auto loan rate on your credit history, which is reflected in your credit report and credit score, according to the Federal Trade Commission (FTC).
La Spisa says creditors will review your credit report, debt ratios, credit payment history, current income, employment history and income-to-payment ratio.
If you make $5,000 a month, for example, and plan to buy a car with an $800-per-month car payment, you will be using 16 percent of your monthly income to make car payments alone. A finance manager will likely consider this to be too high of an income-to-payment ratio and offer you a higher-than-average auto loan rate, La Spisa says.
“If you were in their shoes, you’d want someone with a good credit rating to make sure you get your money back,” he says. “When you’re applying for a loan, you need to prove that you can afford the loan.”
Auto loan rates are also affected by market competition and conditions, according to the FTC . Rates rise and fall depending on the economy and where you live.
La Spisa recommends checking websites such as Bankrate.com to gauge the average auto loan rate for your area.
Using Bankrate.com, La Spisa says the average auto loan rate in Chicago for a 48-month new car loan was about 3.5 percent, as of July 2013. In San Diego, it was about 2.3 percent. Meanwhile, the average national loan rate in July 2013 was about 4.01 percent for a 48-month new car loan.
No matter how low the average auto loan rate is in your city, you’ll most likely pay higher rates if your credit score is low or if you haven’t built up enough credit history.
Edmunds.com, a car-buying website, compiled the average auto loan rates for new cars from more than 900 lending institutions and several prominent credit unions as of May 2013. It found that a 48-month loan rate for a person with a credit score above 720 was about 3.20 percent when borrowing from banks and 2.88 percent when borrowing from credit unions.
For a consumer with a credit score from 630 to 669, a 48-month loan would have an average rate of about 6.44 percent from banks and 5.87 percent from credit unions.
Keep in mind that auto loan rates will generally be higher if you are buying a new car compared to a used car, according to the FTC, and that auto loans ultimately increase the total cost of the car because you’ll be paying interest.
When you first start researching auto loan rates, La Spisa recommends flipping through the pages of your local newspapers. Many local newspapers compare and publish auto loan rates from banks and other financial institutions in the area.
Before selecting an auto loan, order a copy of your credit report so you know where you currently stand, and do your research to determine which lender is offering the best rates.