You may already be aware that interest rates for auto loans are higher when the borrower has a bad credit rating or low credit score. Depending on your financial position and the lender that you choose to use, this rate increase may make a small or large difference in the amount of your monthly car payment.
What Factors Determine My Rate?
From a lender’s point of view, it all comes down to risk. The factors that increase the risk of loan default contribute to a higher rate. Those factors that reduce the risk, result in a lower rate. There are several factors that lenders take into account when reviewing your application and approving your loan.
Credit Score. Your credit score may or may not be a factor in determining your rate. Some lending programs do not use your FICO score when approving your loan. Those lenders look at your overall financial condition and ability to repay the loan. They may take into account your length of employment, or how long you’ve worked in the same type of occupation.
Length of Loan Term. The longer the loan, the higher the interest rate. This is due to the higher rate of loan default on older vehicles that have a tendency to break-down or simply become more expensive to repair than to replace. It’s a wise idea to arrange your loan for the shortest length of time possible, and the difference between a 36 month and 48 month loan may be affordable, with considerable finance charge savings.
Trade-In or Cash Equity. While you may get approved for a no money down auto loan, it’s still a wise idea to put down as much as you can, in order to reduce your APR (Annual Percentage Rate). By making an upfront down payment, you reduce the risk for the lender. This is because they are in an equity position (they are lending less than what the collateral is worth). From the lenders point of view, you are less likely to default on a loan that you have made an upfront investment in, either by cash or trade in equity. This results in a lower risk loan for the lender, which is usually rewarded with lower rates.
Ability to Repay the Loan. If you can demonstrate the ability to afford a car loan, then you may qualify for very good interest rates, as this would be less of a risk for the lender. If you only have just enough money each month to pay for your living expenses and monthly bills, this raises the risk for the lender. If an unexpected expense were to arise, the borrower would be less likely to be able to make their car payment. The higher your debt to income ratio, the higher the risk is for the lender, resulting in higher interest rates. Lenders have strict guidelines as to the percentage of debt to income that they will allow for an auto loan. All lenders are different and some are more lenient.
Past Repossession. A loan offered to someone that has a past repo is considered very high risk and high interest rates result until the borrower has paid car payments for a few years with no late pays. If you have had a repossession that was the result of a bankruptcy, then this is not frowned upon so much by bad credit auto loan companies. If you need a fresh start, you’ll find there are several companies listed here at BadCreditAutomotive.com that can help you.
State Law. Depending on the state that you live in, there may be a maximum interest rate for bad credit auto loans allowable by law. This usually only affects auto loans that are made by buy here, pay here car lots, but may affect an auto loan made by a sub-prime lender. These laws are designed to protect consumers from predatory lending practices.
It’s Not Punishment…
Higher bad credit auto loan interest rates are not an attempt to punish you for having a low credit score. It all comes down to simple costs that the lender must cover in order to stay in business. Here are a few reasons that bad credit car loan companies have higher operating costs, and thus charge higher loan rates.
Delinquency Rate. Auto loans provided to people that have low credit scores have a higher delinquency rate and thus a higher risk of loss. When a prime lender issues a loan to someone with a higher credit score, that loan is considered a low risk loan.
Collateral Recovery. Issuing a loan to someone that has a low credit score, is considered a high risk loan because it is more probable that the borrower may default on the loan payments, which may result in a repossession. This results in added expenses that the lender must incur, which includes hiring a repossession service, account collection costs and the resulting financial loss for the lender. The average repossessed vehicle does not sell for the amount owed on the loan.
Manual Staff Verification. These types of loans are normally issued with various stipulations that must be fulfilled by the borrower. These stipulations can include such things as income and employment verification, verification of credit standings with other lenders and so on. Staff is needed to manually verify this information, and is an added expense for the lender.
