Car Loans: 3% vs 13% – Why the Interest Rate DOES Make a Difference
Millennials are labeled constantly. One of the characteristics that sets us apart from other generations is that we don’t make large purchases. Well, things are changing and the first big purchase for many of us is a car. There are a multitude of factors that financial institutions consider when approving a loan for a vehicle, and there are just as many factors that you should consider when choosing your lender—like who will give you the lowest APR with your credit. There’s a lender out there for each of us.
You could read a book to learn what you need to know, or have a five hour conversation with Aunt Sally who knows how to haggle. You can also just read through our blogs to compile all the information. But know this: the biggest thing to scrutinize is a small number that’s one, maybe two, digits: your interest rate—your APR.
In risk-based lending, a financier reviews your paperwork (including but not limited to your credit report and score), and they peg you into a lending tier. Different places have different tiers and factors that divide their customers among the levels. Here’s a chart for a general example.*
Many of us don’t have the experience yet that personally illustrates the weight of a higher interest rate. Sure, we all agree that higher interest rates on loans are worse than lower interest rates—but let’s upgrade our understanding and pull out those Algebra 1 skills. How do these numbers play out over time?
You picked out your car and are dying to sign the dotted line. You even took notes from Aunt Sally and successfully haggled with the dealer—meaning you need less money to get financed. To keep the example clean (I know those math skills are rusty), here are the details of your grown-up, real-world math problem:
Option One (Tier A)
Amount to be financed: $20,000.00
Loan Term: 60 months (five years)
Monthly payment: $359.00
Total money paid by the end of the loan: $21,562.00
That means you pay $1,562.00 in interest. You could stretch out the term to make payments cheaper each month, but that leaves a larger balance earning interest each day. If you paid the loan back over 72 months, with payments of $304, you would pay $1,879.00 in interest. I’d rather that $300 stay in my savings.
Option Two (Tier C)
Amount to be financed: $20,000.00
Loan Term: 60 months (five years)
Monthly payment: $382.00
Total money paid at the end of the loan: $22,894.00
A lower credit score could make you pay $2,894.00 in interest based on this example! That’s about $1,000 more than Option One in the long-run. What could you do with that money instead? 
Option Three (Tier E)
Amount to be financed: $20,000.00
Loan Term: 60 months (five years)
Monthly payment: $455.00
Total money paid at the end of the loan: $27,304.00
Your credit isn’t the best, but you need a car to get a job so you can make money to pay debts and improve your credit! It’s a cycle, but you don’t have to keep that APR once you secure the loan. In Option Three, you see that if you’re approved, you agree to pay $7,304.00 in interest. Read that again: Seven-thousand, three hundred and four dollars more to pay in interest. That’s a 368% increase in dollars paid to interest. That could pay off two of my student loans!
Math does not lie. If you’re approved in Option Three, I urge you to refinance your vehicle 6-9 months later. Once you’ve shown the ability to pay on-time, and your financial behavior gets reported to the credit bureaus, your credit score will increase, bringing you into a different lending tier, and bringing you closer to a more reasonable interest rate. If a financier doesn’t budge on anything, then it’s better to take your business somewhere else.
Share your consumer knowledge and share this with anyone who just purchased a car or is in the market. Let’s financially grow together.
*The chart used is used for learning purposes only – specifically millennials learning to adult.*
This blog was written by FTWCCU Loan Processor, Michal Broussard.