What Determines Your Interest Rate

What Determines Your Interest Rate

Filed under Information Centre

Interest rates are the cost of borrowing money. This is expressed as a percentage of the price of your new car (known as the ‘principal’ amount).

When a lender calculates the interest rate for your loan they will consider:

  • The degree of risk that the lender is undertaking by lending you money, and the likelihood that you will repay the full amount
  • The length of the loan: a longer loan term will generally attract a higher interest rate.

To make sure you get the best car loan interest rate, first, we’ll focus on you and what you can control, then we’ll explain a bit about how other factors in the market influence interest rates.

Your Credit File

The lender determines the interest rate on your loan by how much risk loaning the money to you will create for them. To assess how able and likely it is that you will repay the full amount of the contract on time, the lender looks at your credit score.

With the information we will give you below, you can take a proactive role in controlling how your credit file appears to future lenders.

Your credit score is a number between 0-1200. The higher score you receive, the better your credit profile. This means that you are more likely to be approved for a loan with a low-interest rate.

Your credit rating is determined by the following factors:

  • Your default history. Which includes things like:

    • any overdue debts
    • mortgage repayment defaults
    • credit card payment defaults

    A default is recorded on your credit history if you miss a payment which is more than $150, and if it becomes more than 60 days overdue. Before the default is recorded, the credit provider must send you 2 written notices: the first requesting payment, and a second a notice that the debt will be reported to a credit reporting body. A standard default will remain on your credit report for 5 years. A bankruptcy stays on your file for 7 years.

    Type of credit provider

    The type of credit provider who has made enquiries on your credit score in the past will impact your score. There are different perceived risks associated with an approach to different types of lender. Research demonstrates that there are different risks with lenders in different industries: for example with a bank, a store finance provider, a utility or a non-traditional lender.

    Your ‘credit-shopping’ pattern

    The fewer lenders you have approached for credit, the more attractive your business is to a lender (this is just one good reason using a broker can give you an edge).

    The amount and type of credit applied for

    The size of the loans that you have held and the credit limits you have applied for can impact your credit score. Your credit score will predict how likely it is that an adverse credit event will occur in the next 12 months. Your broker will use this perceived risk to assess your eligibility for the loan, and the lender will consider this risk in order to set the interest rate for your loan.

    Length of your credit history

    If you are a recent graduate and you haven’t had a credit card or utility bills in your own name, you will have a short credit history. Some lenders will weigh this against your current employment situation and other information, to calculate the overall risk of lending you money. A car finance broker will be able to assist you with expertise on which lenders to approach. If you are entering the lending market for the first time, your broker will be able to guide you to give you the best opportunity to establish a good credit rating.

    Your Net Worth

    You Net Worth is the difference between your assets - what you own - and your liabilities - how much you owe. Assets include your home, property, superannuation, savings, the value of any business or investments that you own.
    Home Mortgage/Investment loans
    Superannuation Personal/Business loan
    Value of business Car loan
    Value of investments Student loan (HECS)
    Car/boat/caravan Interest-free loans

    You can calculate your net worth in 5 minutes by using this calculator, before applying for a loan. Your net worth will inform a lender regarding the strength of your current financial situation. A respectable savings history in your bank account will work in your favour and attract a better interest rate.

    Your Personal and Business History

    Lenders will perceive you to be a lower risk client if you have:
    1. Stable employment history
    2. Stable personal residence
    3. Stability at your current commercial address if the car loan is for business purposes
    4. Your type of employment income
    5. Any directorship or proprietorship you hold.

    Having a stable employment history and steady residence is reviewed as credit strength. The number of different employers and residences you have is taken into consideration for the formula for your interest rate. This extends to stability at your current business address if you are using the car for business purposes. The greater stability you present, the less of a risk you are to a prospective lender. By making enquiries with a car finance broker, you can assess whether you are able to get good rates on a loan right now, or whether you might be better waiting for a few months to improve your credit application.

    Your Previous Successful Loans

    If you have successfully applied for and honored a loan in the past, this demonstrates that you will be able to do this into the future. This could reduce the risk that you present to a lender, when compared with someone who has never had a loan before. The better your loan history, the higher the chance you have of securing a loan with a lower interest rate.

    Great info - but what does it mean for me?

    Using the knowledge you now have about your credit rating, you can conduct your finances to maximise your credit score. A car finance broker will be able to help you to establish borrowing and repayment habits that will put you in a good position for future finance applications.

    Other Important Considerations to what determines your interest rate?

    1. Type of Vehicle

      The type of vehicle that you buy will affect your car loan interest rate. When you take out a car loan, the lender takes security over your new car when they provide finance. The lender will consider the depreciation and resale value of the car when they set the interest rate on your loan.
    2. If you default on the loan, the lender may sell the vehicle in order to recover their costs.

      Should I Buy A New Or Used Car?

      A brand new car purchased through an Australian dealership is considered by lenders as a less risky lend than a used car through a private seller. A highly modified or vintage car, or an overseas model not purchased through an Australian dealer presents greater risk for the dealer being able to recover the principal. With these riskier loans a lender may require you to take out an unsecured personal loan, which could have higher interest rates.

      Will I Get Lower Car Loan Interest Rates If I Have a Deposit?

      Yes, you will. The amount that you borrow also affects the interest rate. Having a deposit shows the lender you are financially disciplined. However, for a large loan, for example, if you borrow more than $18, 000 you will also generally receive a lower interest rate. This isn't the best reason to get a larger debt, but it is good to know if you want to buy a high end car. A Car Finance broker will be able to help you determine how much you should spend. As you will see next, a short loan for a smaller amount may be a more most beneficial option.
    3. Length of the Loan

      Short-term loans will generally have a lower interest rate. When a lender determines the interest rate for your loan, they take into account:
      1. predicted inflation during the term of your loan
      2. interest rate fluctuations
      3. the economy as a whole.

      These variables are easier to predict in short-term markets. Inflation means that the amount that you borrow now will have less purchase value when you repay it. Because the long-term economic conditions are harder to predict, lenders charge a higher interest rate to mitigate the risk that they may lose money on the deal if the interest rates increase above what they charge to their clients. So on a short-term loan, you are likely to receive a lower interest rate than if you decide on a longer loan.

    How Do I Get the Best Car Loan Rates?

    Before a lender provides you with a contract for finance, the lender wants to know not only whether you have the capacity to pay back the loan, but how likely it is that you will pay back the loan. When you use a car finance broker they do this assessment so you're only submitting a loan application to a lender who will approve you for the best car loan rates you qualify for. Your broker can manage the whole process, from initial information gathering and research, application to final settlement of the car purchase.

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