If you borrow $10,000 for a car, you will eventually pay back more than $10,000. This is because the lender will charge interest to compensate it for the risk taken when lending you money. Interest also compensates the lender for the opportunity cost it must pay to have its money tied up in your loan. How are interest rates determined, and what other costs might you pay when taking out an auto loan?
Low Risk Equals Low Interest Rates
Those who are a low risk to a lender are going to pay lower interest rates. If your credit score is above 700, you may not have to pay any interest at all or get a rate that is below 3 percent. However, any rate under 4 percent should be considered below average, which means you are getting a good deal.
High Risk Equals High Rates and Other Conditions
If you have a credit score below 640 or other red marks on your credit report, you should expect to receive an interest rate of 10 percent or higher. In fact, you may pay as much for an auto loan as you would for a credit card if you are considered a subprime borrower. In addition to a high interest rate on your auto loan, you may also be required to get a cosigner or agree to make multiple payments per month.
What Other Costs May You Incur?
In addition to paying interest on the loan, you may also be subject to dealer fees and state taxes. For instance, you may be charged up to $500 in document fees as well as sales tax on the purchase. One good way to lower your sales tax may be to first trade in your old car.
The value of your trade will be applied to the price of the new car, which will lower your overall tax burden. If you owe anything on your old car, that will then be added back into the price you pay for the new car.
In addition to state taxes and dealer fees, you may also have to pay DMV fees as well as an increase in insurance costs. The dealer will be able to explain all fees and costs before you sign any paperwork to buy the car.
Most people need a car to get to work, school or other social events. Therefore, it is important to know all the costs you incur to purchase a car and own it for several years. Understanding those costs ahead of time makes it easier to shop around with confidence until you find the deal that works best for you.