It is no secret that the Federal Reserve makes headlines from New York to Hong Kong whenever it raises its benchmark interest. This is not surprising since any increase is likely to push up the cost of borrowing for everything from mortgages and auto loans.
It’s the other aspect that determines the amount you’ll have to pay when you take out money to buy a vehicle or a home. It’s up to you: the lender you select. This is because the amount the lender will charge for a loan may differ drastically from one lender in the same. This is why it’s important to compare.
My study of auto loans has shown that the majority of consumers do not take advantage of this as it could result in them paying hundreds or millions of dollars in the course of the loan or cause them to purchase a lesser-quality vehicle than originally thought. However, it’s fairly easy to stay clear of that.
The majority of us shop till we’re broke for discounts on computers, clothes, or just about anything else. On the internet, finding the most affordable price among items and companies is more simple than ever before.
A recent study discovered that 92 percent of consumers seek out the lowest price when shopping and 80 percent said that they’re willing to go to great lengths to score an affordable price.
You’d think that this reasoning could be carried over to larger purchases you make in life. For a majority of Americans, cars are the biggest or second-largest home asset they have. Additionally, the majority of automobiles are bought by means of auto loans.
Yet, while they tend to work hard to get the best deal possible on the cost of their car, many don’t shop in search of the best interest rates. This isn’t restricted to auto loans. The majority of consumers don’t do any research when they take out a home mortgage or an individual loan.
Even though the financing cost for loans of a typical nature could make up a substantial part of the total cost of purchasing a car, let’s say, for instance, you’re buying a car worth $25,000 and financing the whole purchase. A loan of $25,000 at 4 percent will cost you $2600 in interest over its term, which would add 10 percent to the actual cost of the vehicle.
What are the factors that determine a rate?
Let me describe how a lender determines the interest rate they want to pay.
The lender generally begins at a base rate like that of the Prime rate or even the U.S. Treasury bond, both of which can fluctuate up and down with the Fed’s goal rate.
Other factors that influence the final rate you pay are the risks specific to you as a borrower, such as credit scores, your debt-to-income ratio, and the markup of the lender, which can be affected by a range of variables. In the case of secured loans, including auto and mortgage loans, the size of your downpayment, as well as the value of the asset, could affect the rate.
There are a few lenders who will not cost the same loan with the exact borrower in the same way. In fact, more than half of people who borrow overpay for their auto loans.
This is the shocking conclusion of the study that I conducted together with Brigham Young finance professors Bronson Argyle and Taylor Nadauld. We came to our findings after analyzing anonymized data that was provided by the software services firm Visible Equity with two million car loans granted by 326 financial institutions.
The data helped us analyze interest rates on automobile loans that originated in the same metro area and over a similar time frame for equal amounts for similar-priced vehicles as well as for borrowers with comparable credit scores.
We discovered that nearly 1 in five consumers get loans that are more than two percentage points more than the most competitive rate offered for those who have similar credit scores.
As an example, Mark from Nashvil, le witaan rating of 71, decided to pay 5.85 percent to purchase a second-hand Toyota Camry for $18,033. This was the typical loan amount in our research. Another bank in the same area, however, offered Jamieae a price that was 4.2 percent for the same amount even though she had the same credit score. This means that Mark will be overpaying throughout the loan. That’s roughly $17 each month.
Compare that with the probable outcome of the Fed increasing rates by a quarter-point in March, and that will be much less detrimental to the cost of obtaining loans. If the price of a car is lowered increase by 0.25 percentage points, the monthly installments on that average car loan will increase by only $2 per month, which is around $120 over five years.
Additionally, we discovered that many buyers who are overpaying are able to manage by purchasing old, less expensive vehicles rather than searching to get a better rate. If the buyer had shopped for a better rate, he would have spent all that extra $1,000 on a more expensive car.
The same principles can be applied to other loans, too. A study by the federal government revealed that failing to search for the most favorable mortgage rate can easily cost you 3,50000 in just the first five years of your loan, as well as thousands more over the average mortgage.
Why don’t people shop for loans
?What is the reason for this apparent uninterested attitude towards buying interest rates?
Credit applications often involve documents, which could be a hassle or stressful. It may require an extra trip to a lender’s office if buying automobiles is time-consuming enough. The borrower may not be aware there are better rates to be found.
In reality, we discovered that the average consumer only needs to compare three deals to find something close to the highest cost.
Other false assumptions could be involved, for instance, the belief that you must finance your vehicle through a dealer (you do not) and that your bank will provide you with the best rate (often not, based on our research), and that the dealer’s rates will be the most favorable (not always) or that your credit score may be affected if you apply to several places ( it won’t).
One of the reasons appears to be the fact that people typically do not understand the potential of compound interest and how small changes in monthly payment amounts make a difference.
It’s certainly not as thrilling to search for loans as it is to drive a car for a test drive. However, most of these issues can be overcome or should not be a problem at all. Although it requires some extra effort to find alternative financing options, modern technology makes it easier than you believe. Various lenders can utilize a lot of this financial documentation. Websites such as the Bankrate, Credit Karma, and NerdWallet let you evaluate multiple interest rates.
The bottom line is that car buyers are actually paying more, but for less, by not conducting their due diligence to locate the most affordable financing options. When it is about credit, it’s best to search for a variety of options.