When someone takes out a loan to buy a car, he generally pays interest on the loan's principal. Interest can apply in a number of ways. These include a variable rate linking to the current market interest rate, or as a fixed rate of interest that remains stable over the course of the loan's repayment. Either way, the same set of factors affect the rate a borrower pays.
Market Interest Rates
The main factor affecting rates charged by finance companies is the prevailing rate of interest offered by other lenders in the economy. While all lenders offer different rates, many base them directly or indirectly on the prime rate. The prime rate links to the fed funds rate, set by the U.S. Federal Reserve through open market operations. Large economic factors, such as investor confidence, also can affect interest rates.
Credit Rating
A finance company offers different rates to different borrowers. The exact rate depends in large part on the customer's credit rating. This rating, as calculated by credit-rating bureaus, gives lenders insight to the risk of lending to an individual. It provides a single number score that indicates his creditworthiness. Often, the interest rate a lending company offers will tie directly to this number.
Income
In addition to the credit rating, the lender will also look at the borrower's income. In the eyes of a lender, an individual's income directly affects his ability to repay the loan. For this reason, borrowers with larger incomes generally receive lower rates. In addition, people with significant financial resources receive lower rates, because lenders consider them to be at a lower risk of default.
Finance Company Policies
Although most finance companies use the same factors to calculate the interest rates they offer customers, each company will generally have a different set of rates. This is because the rates offered customers may reflect company policies, such as how much profit the lender expects from each loan, and how it measures a borrower's default risk. In addition, some companies may have special rates for specific car dealers, which can affect your interest rate, too.
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