How Are Interest Rates on Cars Determined?

When shopping for a car, you'll notice that auto loan interest rates tend to fluctuate dramatically. One financial institution may give you a 4 percent interest rate while another may give you a 5.4 percent rate. While the rates may appear to change with the wind, multiple factors determine your loan rate, including the amount the car costs, your credit history and the state of the economy.

Credit History

Credit history can single-handedly decrease or increase your potential auto loan interest rates. When you submit a credit application, most lenders immediately comb through your past credit history. The main points of interest include your credit score and current and past credit accounts. Generally, a credit score below 620 results in increased rates as that score range represents high risk. When looking at your credit accounts, lenders check if you're in good standing or if you've been hit with 30-, 60-, or 90-day late payments. If you don't have late payments and you have a high credit score, you will always qualify for lower interest rates than if you had a low credit score or made late payments.

How Much You Borrow

A loan of $5,000 will usually carry lower interest rates than a loan of $20,000, credit history notwithstanding. Larger loans carry more risk. A lender's primary goal when granting a loan is to get that money back. When deciding to deny or accept a loan application, lenders look at how much a person is borrowing and weigh that against the possibility of not seeing the money returned. A loan of $5,000 doesn't carry near the risk that a $20,000 loan does.

The Economy

The economy can increase or decrease interest rates. When banks get spooked by a rough patch in the economy, credit availability can tighten, which normally results in higher interest rates. Conversely, when the economy booms, interest rates typically fall. For example, when the economy sputtered in 2008, the average interest rate for a 36-month used auto loan was 7.75 percent, according to Bankrate.com. As of June 2011, the average interest rate for a 36-month used auto loan is 4.72 percent, according to Bankrate.com.

Where You Apply for a Loan

By applying for a loan outside of your bank or credit union, you may incur higher interest rates. If you have previously taken out and paid for loans or lines of credit from your financial institution, you have shown you're responsible and you're not a high risk borrower. Banks and credit unions that have never dealt with you before will see your past loans and lines of credit, but they might not be willing to give you as low of an interest rate as the financial institution you belong to.

Down Payment

By putting more money down, you show the lender that you're willing to use a portion of your own funds to pay for the car upfront. The amount of your down payment doesn't affect interest rates to the extent that other factors do.

Used Cars

If you're shopping for a used car, you'll likely find an interest rate comparable to that of a new car loan. When borrowers default on their loan, the lender attempts to get the money back by selling the car. Used cars sell for a lower percentage of the approved loan than new cars do, so the lender takes on a higher risk by approving a used car loan.