Financing a car works much like financing a house. A buyer negotiates a price and any available discounts are taken. A down payment is made against the principal, reducing the price further. Any sales taxes, registration fees and title charges are added on and a final purchase price is calculated. This final number is broken out over the term of a loan, with a predetermined interest rate calculated and added on each month.
Auto financing is secured credit, as the car will be used as collateral if the borrower defaults on the loan.
As with any loan, a person's credit score is the measuring stick of their creditworthiness. A credit score is based on a number of different factors, including debt to income ratio, debt to asset ratio and repayment history or level of unsecured debt, to name a few. The highest possible credit score is 850 and the closer a person comes to that number, the lower the interest rate. Well-qualified buyers are typically defined as people with a credit score of 750 to 760 and higher. These are sought-after borrowers and car companies give their best financing to them.
Car loan rates go up as the borrower's credit score goes down. Typically, the rate will increase 1/8th of 1 percent for every 25 to 50 point drop from the well-qualified level.
Car loans are easy to determine as all three factors in the equation are static: the purchase price, the term and the interest rate. The interest rate is an annual percentage rate (APR). Divide the APR by 12, which determines the monthly interest rate. Divide the purchase price by the term of the loan. Take the monthly principle, add it to the monthly interest and that is the monthly payment for the vehicle.
