Why Are Interest Rates So Important To Car Finance?

When interest rates rise in the UK, you may be wondering how they modify your ability to get a loan and how much the loan will cost. Car finance in particular is very much affected by interest rates and they can be very influential. Most car finance agreements include some form of interest to pay so it can be worth brushing up on your knowledge before you start applying. The guide below looks at how interest rates can affect your car finance and the personal factors that can make interest higher.

What is an interest rate?

When you borrow money, lenders will charge a fee to do so, and this is called the interest rate. The interest rate will be shown as a percentage of the total amount of the loan. The interest reflects the cost of borrowing and will be set on a few different factors. You will agree on the proposed interest rate when you sign the car finance contract. Using a reputable car finance company can help to make sure you’re getting a fair interest rate for your personal circumstances.

Do you have to pay interest on a car loan?

Most car finance agreements will require you to pay interest on your loan. This is one of the main ways the lender can make a profit, so they are often popular on car loans. Agreements like hire purchase cars usually have interest to pay and it will be included in your monthly payments. PCP car finance deals could be offered with 0 interest to pay but these agreements are usually only offered on higher loan amounts such as brand-new cars.

How much interest will you pay on your car finance?

It can be hard to pinpoint how much your car finance is going to cost you. The rate of interest you are offered can depend on the lender, your credit score, the size of the loan and the length of the loan term. This is why it’s always recommended you shop around for the lowest interest rate offered to make sure you’re getting the best deal possible. Below are a few factors which can affect your interest rate offered.

Your credit score.

A bad credit score makes you more of a risk to lenders. This is because your previous history of borrowing indicates you’ve made financial mistakes in the past. This can include missed or late repayments. Lenders can set a higher rate of interest for applications who are higher risk to safeguard themselves from any losses if the customer fails to repay.

The size of the loan.

This can be a tricky one to grasp but usually, a smaller loan amount can equate to a lower interest rate. This is because you are borrowing less from the lender and the risk is lessened. However, if you choose to finance through PCP, which offers low monthly payments, you could also benefit from a low interest rate too. This is because much of the loan value is deferred until a final balloon payment. This is why we stress the importance of comparing car finance interest rates and different loan types.

Length of the loan term.

One great benefit of car finance is being able to alter the loan term length to suit your budget, A longer loan term will decrease your monthly payments because you are taking longer to pay the loan off. Usually car loans last between 3-5 years. Choosing to finance car over a shorter period will increase your monthly payments but it will reduce how much you pay in interest.