Factors used by lenders to calculate car loan interest rates

There are many factors that most lenders use in calculating car loan interest rates. This makes the interest rates one of the aspects of a car loan that is difficult to understand. However, you can somehow obtain a rough estimate of your car loan rate by knowing some of the factors used in the calculation. This article provides some of the factors used in the calculation. This includes the following:

Credit history

The borrower’s credit history is the most significant factor that is considered by lenders in calculating the interest rate for a loan. The credit history includes a three digit number commonly known as the “credit score”. Most lenders use the credit score to assess a borrower’s credit worthiness. A good credit score holder therefore is more credit worthy compared to a low credit score holder. This is the reason why lenders place lower interests on loans for good credit holders since they have the greatest tendency to pay loan back. Bad credit holders on the other hand incur higher interest since lenders view them as risks with the greatest possibility of running away from their credit obligations.

Interest rate types

The amount of interest that a loan has is also dependent on the type of interest that loan providers use. In most car loans, lenders use two types of interest that includes the “simple interest rate” and the “compound interest rate”. In a simple interest rate loan, the interest is calculated based on the amount that the borrower needs to pay to the lenders. In a compound interest rate on the other hand, the payment is based on the amount that the borrower owes from a lender, the interest tied to it, and the interest placed on the interest. This makes compound interest loans more expensive compared to those that use simple interests.

Ratio of income and debt

Car loan providers also consider a borrower’s income and debt ratio in calculating the interest rate. This ratio determines the amount of money that is taken from the income of an individual that goes to the payment of his debt. The calculation is based on a given ratio which is presently around 28/36 for Americans.

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