Understanding how car loan interest rates change based on loan term

When you decide to purchase a car, one of the key factors influencing your total cost is the car loan interest rates. Whether you are financing your vehicle through a dealership or a bank, understanding how car loan interest rates change based on the loan term is crucial. A car loan’s interest rate will determine not only your monthly payments but also the overall cost of the vehicle over the life of the loan. In this article, we will explore how loan terms affect car loan interest rates and provide insight into how you can use this knowledge to get the best deal on your car loan.

What are car loan interest rates?

Car loan interest rates refer to the additional cost you incur for borrowing money to purchase a car. These rates are typically expressed as an annual percentage rate (APR) and are calculated on the loan amount (the principal). The APR can either be fixed, where the rate stays the same throughout the loan period, or variable, where it changes according to market conditions.

Understanding car loan interest rates is crucial because they have a direct impact on how much you will pay monthly and the total cost of your car loan. However, the interest rate is not set in stone—it can vary depending on several factors, with the loan term being one of the most significant.

How loan terms influence car loan interest rates

A loan term is the length of time over which you will repay the loan. Loan terms for car loans typically range from 12 months to 72 months or even longer. The loan term you choose can greatly affect the interest rate offered by the lender and, consequently, the total cost of your car loan.

1. Longer loan terms often have higher interest rates

One of the most noticeable effects of choosing a longer loan term is the increase in the car loan interest rates. Lenders tend to charge higher interest rates for longer loan terms for a few reasons:

• Increased risk for lenders: With longer loan terms, lenders face more uncertainty about the borrower’s ability to repay the loan. Longer terms mean that economic conditions may change, which can affect your financial stability. To compensate for this added risk, lenders often raise interest rates.
• Higher total interest paid: The longer the loan term, the more interest you will pay over the life of the loan, even though your monthly payments may be lower. Lenders take advantage of this extended repayment period by charging a higher rate of interest.

While longer loan terms (such as 60 or 72 months) might seem appealing because they lower monthly payments, it is important to understand that you may end up paying significantly more in interest over time. For example, on a ₹20,00,000 car loan with a 6% interest rate, the difference in total interest between a 36-month term and a 72-month term could be substantial.

2. Shorter loan terms often have lower interest rates

On the other hand, shorter loan terms tend to have lower interest rates. Lenders are less likely to view shorter-term loans as risky because they are paid off more quickly. As a result, they typically offer more favourable interest rates for shorter loans, such as 36 months or 48 months.

• Lower risk: Shorter loans mean the lender’s exposure to risk is reduced. The faster you repay the loan, the less likely you are to default. For this reason, lenders often provide more competitive interest rates for short-term loans.
• Smaller total interest payments: Although the monthly payments on shorter loans will be higher, the total interest paid over the life of the loan will be lower. If you can afford the higher monthly payments, a shorter loan term could be the more cost-effective option, as it reduces the overall interest expense.

For example, on a ₹20,00,000 loan with a 6% interest rate, opting for a 36-month term would cost less in total interest than a 72-month loan. Additionally, the shorter loan period allows you to pay off your car faster, freeing up money for other financial goals sooner.

3. Loan term impact on loan amount and eligibility

It is also important to note that the loan term can impact your car loan eligibility. If you choose a longer-term loan, your monthly payments may be lower, which can make the loan more affordable based on your income. However, this may also reduce the total amount of the car you can afford.

For example, if you choose a loan with a 72-month term, your monthly payment will be lower compared to a 36-month loan. This could allow you to afford a more expensive car, but it also means you will be paying more interest over time. In contrast, if you go for a shorter loan term, you might be able to borrow less money to keep your monthly payments manageable, but your total interest paid will be significantly reduced.

By carefully considering the loan term, you can manage both your monthly payments and the overall cost of your car loan.

Factors that affect car loan interest rates beyond loan terms

While the loan term is a significant factor, there are other variables that lenders take into account when setting car loan interest rates:

1. Car loan eligibility

Your car loan eligibility is one of the primary factors affecting the interest rate you are offered. Lenders evaluate your financial situation, including your credit score, income, employment history, and debt-to-income ratio, to determine whether you are eligible for a loan and at what interest rate.

• Credit score: The higher your credit score, the more likely you are to qualify for a car loan with a lower interest rate. A higher credit score signals to the lender that you are a responsible borrower and are less likely to default on the loan.
• Income and employment: A stable income and a strong employment history show lenders that you have the financial capacity to repay the loan. Lenders may offer lower interest rates to borrowers with a steady income stream.
• Debt-to-income ratio: If you have significant existing debt, lenders may charge you a higher interest rate to mitigate the risk of default.

2. Down payment and loan-to-value ratio

The down payment you make on your car also influences the interest rate. A larger down payment reduces the loan-to-value (LTV) ratio, which indicates the risk for the lender. If you make a large down payment, it reduces the amount you need to borrow, which in turn lowers the LTV ratio and may result in a lower interest rate.

Lenders typically prefer an LTV ratio of 80% or lower, meaning they like borrowers to make a down payment of at least 20% of the car’s purchase price.

3. New vs. used car loans

Interest rates can also differ depending on whether you are purchasing a new or used car. New cars typically have lower interest rates compared to used cars, as they are less likely to depreciate quickly. Lenders consider new cars to be a safer investment, while used cars can carry more risk.

To simplify the loan application process, you can use the Bajaj Finserv app, which provides a user-friendly interface to compare loan options for new and used cars. It helps you make informed decisions based on your preferences and budget.

How to get the best car loan interest rates

To get the best possible car loan interest rates, consider the following tips:

Improve your credit score: A higher credit score improves your chances of securing a lower interest rate.

1. Save for a larger down payment: A larger down payment lowers your LTV ratio and shows the lender you’re financially responsible.
2. consider a shorter loan term: If possible, choose a shorter loan term to secure a lower interest rate and pay off the loan faster.
3. shop around for lenders: Different lenders offer different interest rates, so make sure to shop around and compare offers.
4. Use a car loan eligibility calculator: Many online tools allow you to calculate your eligibility based on your financial profile. This can help you understand the loan terms and interest rates you might qualify for before applying.

Conclusion

Understanding how car loan interest rates change based on loan term is vital when financing your vehicle. While longer loan terms may offer the benefit of lower monthly payments, they often come with higher interest rates, resulting in higher total costs over the life of the loan. On the other hand, shorter loan terms usually offer lower interest rates and a lower total interest payment but come with higher monthly payments.

By considering factors like your loan term, car loan eligibility, down payment, and the type of car you are purchasing, you can choose the car loan option that best suits your financial situation and goals. Always compare different lenders and loan offers to secure the best car loan interest rates available.