Purchasing a car is a great investment. However, because of the expense, consumers may require an auto loan. Like any loan, a car loan must be paid back in monthly payments over a set amount of time with interest. There are regulations set by states on the maximum interest rates that can be charged on auto loans. Consumers should always read the fine print before signing a loan contract.
Auto loan interest rates are governed by state regulations. Depending on the state, laws concerning interest rates vary. For example, in Alabama, the maximum interest rate is 8 percent. That means rates for each lender there will fall at 8 percent or less. Some states have higher rates, such as Massachusetts, which is at 20 percent. Iowa set its rate at 2 percent above the monthly 10-year constant maturity rate of U.S. bonds. Some states have no limit, such as Maine.
Auto loan companies use a number of resources to determine what kind of loan to make to the consumer. Most of the factors are financial. One indicator is the consumer's current credit score. Lenders look at the consumer's Fair Isaac Corp. (FICO) score to determine an interest rate. Lenders also look at consumers' financial situation. Factors such as income and the down payment determine the length and interest rate of the loan.
The loan length determines the interest rate on the auto loan. Deciding on the length can be a difficult decision. A short-term loan finalizes the purchase of the car but can result in a high monthly payment and a lofty interest rate. A long-term loan can be easier to pay since the interest rate is lower. However, if consumers' financial situations fluctuate or they didn't adequately prepare for the long term, those monthly payments can eat up income and savings. Keep in mind that even a low interest rate and perfect finances can cost the consumer more. Popular website Cars.com illustrates this an example of a car with a sticker price of $22,000. If the loan's term is three years with a 5 percent interest rate, the consumer actually pays $23,737 to the loan company. But if the loan's term is five years with a 5 percent interest rate, the consumer pays $25,510 -- $1,773 more than the three-year loan.
