Car Loan Interest Rates Explained

Our guide explains how interest rates impact your car loan repayments and overall borrowing cost, how to get the lowest rates, must-know tips and frequently asked questions.

Updated 16 February 2024

Summary:

Every car loan contract stipulates the interest rate and the total interest costs you'll pay. The interest is the cost you pay for borrowing money and it's repaid alongside the original loan amount you borrow.
In New Zealand, you'll usually have a contract with a fixed interest rate when you take out a car loan. This means the rate of interest you pay on your loan won't change over time. Almost all car loans in New Zealand come with this type of interest rate.
Why is this important? Fixed interest rates make it easier for you to budget. Your monthly loan repayments will stay the same throughout the entire term of the loan, giving you stability and predictability in your finances.
However, your car loan's interest rate drives the overall cost of the loan - even a 2% or 5% p.a. difference can add thousands to your loan repayments over the loan's life.

Know This First: Our examples explain the differences between car loan contracts:

Reasonable Interest Rates: If you have a good credit history and strong affordability, a competitive interest rate might range between 10% to 15% p.a. These rates reflect your creditworthiness and the current market standards.
Excessive Interest Rates: Rates that soar above 20% p.a. can be burdensome, especially if your credit history or affordability don't justify them. Many 'bad credit' car loans come with 25% or even 30% p.a. interest rates, which we argue is unaffordable at best and predatory lending at worse.

Important - Our Glossary of Key Terms in Car Loan Repayments

Interest rates in car loan contracts use specific words which we explain below:

Fixed Interest Rate: An interest rate that remains constant throughout the loan term. In New Zealand, most car loans use fixed rates, providing predictability in repayment amounts.
Default Interest: A higher interest rate charged on a loan when a borrower fails to make payments when they're due. Default interest is common in car loan contracts and the rate kicks in when payments are missed, significantly increasing the loan cost.
Refinancing: The process of replacing an existing loan with a new loan, typically to achieve a lower interest rate or different repayment terms.

How Interest Rates Affect the Overall Cost of a Car Loan

How much your pay in total for your car loan is driven by the how much you borrow, the repayment terms you agree to and the interest rate. To make an informed decision about what loan to take out, it's important to understand some key facts about how the interest rate affects how much you'll repay each month and the total cost of your loan.

We outline the costs and risks with an example the table below.

The Impact of Different Interest Rates on a $20,000 Car Loan Over 5 Years:

Interest Rate (p.a.)	Monthly Payment	Total Repayment	Total Interest Cost
10%	$425	$25,496	$5,496
15%	$476	$28,548	$8,548
20%	$530	$31,793	$11,793
25%	$587	$35,222	$15,222
30%	$647	$38,824	$18,824

The table above shows us just how much the interest rate on a car loan can affect how much we end up paying over the example five-year repayment period. Let's break it down:

At 10% interest, you're paying an extra $5,496 on top of the $20,000 you borrowed. Your monthly payment stays manageable at $425.
Jump up to 15% interest, and things start to heat up. You're now paying $3,052 more in interest compared to the 10% rate, totalling $8,548.
At 20% interest, the total interest cost leaps to $11,793. That's over half of what you originally borrowed.
25% interest rates makes things tougher, with a total interest cost of $15,222. Your monthly payments are now at $587.
And at 30%, it's almost like you're buying the car twice - the interest alone is $18,824, making the total repayment $38,824.

Know This: The higher the interest rate, the more you're going to pay over the life of the loan. It's crucial to compare car loans and look for the lowest possible interest rate. Given the amount the average New Zealander borrows for a car loan (and the 3-7 years it typically costs to repay), a 5% or even 2% lower interest rate can save thousands of dollars.

Budgeting for Payment Dates is Essential:

Having enough money to make every car payment is crucial; if you miss one, the late payment fees start to rack up.
Fortnightly payments might suit those paid similarly, while monthly payments could be easier for those on a monthly salary.
Whatever you do, make sure your car loan repayment is prioritised to leave your bank account and has no chance of bouncing.
We suggest downloading a budgeting app to help you keep on track, as timely repayments minimise the risks and associated late repayment fees.

How to Qualify for a Lower Interest Rate

Your car loan's interest rate will drive the total cost of financing; getting a lender to offer the lowest possible rate is important to save money.

The CCCFA is strict and lenders are obliged by this law and its tight regulations to ensure you're financially secure before approving any car loan debt.

Some of the steps to take start well before you make a car loan application; we outline what you need to know in three key areas to help you lower the cost of borrowing:

1. Strengthen Your Credit History:

Consistent Bill Payments: Ensure all your bills, not just credit cards or loans, are paid on time. Payment history is a significant factor in your credit history, and lenders don't like lending to anyone with a history of late payments.
Debt Reduction: Lower your existing debt, especially high-interest debts like credit card balances. Lenders closely look at your debt levels under the CCCFA regulations and can decline a loan if you have too much debt. Lower debt levels improve your debt-to-income ratio, a key factor lenders consider.
Credit Report Accuracy: Regularly review your credit report and rectify any inaccuracies or disputes - this guide explains how to do this. Errors in your report can unfairly lower your credit profile.

2. Demonstrate Affordability and Stability:

Stable Income: A steady and reliable income reassures lenders of your ability to make regular payments. Proof of long-term employment and/or a stable career can positively impact the interest rate you're offered.
Lower Debt-to-Income Ratio: This ratio measures your monthly debt payments against your income. A lower ratio shows you're not overburdened with debt, making you a stronger borrower and an attractive candidate for lower interest rates.
Budget Management: Illustrate responsible budget management wirh regular savings and controlled spending indicate financial discipline. This makes you less of a risk to lenders.

3. Other Considerations:

Larger Deposits: If possible, offer a larger deposit on the car. This reduces the loan amount, decreasing the lender's risk and potentially lowering your interest rate.
Gaurantor: Consider a gaurantor with a strong credit profile, such as a parent. This can significantly improve your loan terms, as the lender's risk is reduced. This guide explains car loan guarantors in detail.
Shop Around and Compare: Don't settle for the first offer. It's essential to compare rates from various lenders, including banks, credit unions, and online lenders.

Know This: By following the above tips, you can improve your creditworthiness and demonstrate to lenders that you are a responsible borrower. This, in turn, can lead to being offered lower interest rates on car loans, saving you a significant amount of money over the life of the loan.

While improving your credit and demonstrating affordability takes time, the financial benefits can be substantial given the wide range in interest rates currently offered by car lenders.

Understanding Penalty Interest on Car Loans

When you take out a car loan, you agree to make regular payments by certain dates.

If you miss a payment, not only might you be charged a late payment fee, but you could also face something called 'penalty interest', which is included in standard car loan contracts. We explain what you need to know in detail:

What is Penalty Interest?

Penalty interest is an extra interest charge applied to your loan when you don't make payments on time. It's over and above the standard interest rate you're already paying.
For example, if your car loan has a standard interest rate of 15% p.a. and you miss a payment, the interest rate might increase to 20% p.a. (the original 15% plus a 5% penalty) until you catch up on the missed payment.
This increase is meant to encourage timely payments and covers the lender's risk of late or missed payments, although it's arguable that it may be a fee grab as late fees are usually charged as well.

How Does Penalty Interest Work?

This best is explained with an example - we use John's case below to make the costs clear:
John has a car loan of $20,000.
The standard interest rate on his loan is 15% per year.
John misses a payment, and it takes him two weeks to catch up; in that time, the interest rate increases to 20% (which includes a 5% penalty rate) on the outstanding balance.
John also incurs a $25 late payment fee.

Calculating the Extra Cost:

Normally, the interest for two weeks on his loan would be a certain amount (based on the 15% annual rate).
With the penalty interest rate of 20%, the interest for these two weeks is higher.
The difference between these two amounts is the additional cost due to the penalty rate.
In John's case, this additional interest for the 2-week period is approximately $38.46.
Total Extra Cost: For the 2-week delay in making a payment, John will pay the $25 late fee plus about $38.46 extra in interest, totalling around $63.46 more than he would have paid if he made his payment on time.

Our view: Penalty interest can significantly increase the total cost of your loan, especially if late payments happen often. If you think you might miss a payment, talk to your lender - don't leave it to chance, as the fees, as outlined above, can be expensive and increase any financial problems you're having. Our car loan hardship application guide explains more.

Questions to Ask Your Lender to Understand Your Car Loan Interest Rate:

1. What is the exact interest rate I will be charged?

Typical Answer: "Your interest rate will be X%, fixed for the term of the loan".
Importance: This determines your monthly payments and the total cost of the loan. Knowing the exact rate helps you budget accurately.

2. Is this the best rate you can offer based on my credit history?

Typical Answer: "Based on your credit history and affordability, the best rate we can offer is X%".
Importance: This question encourages lenders to offer you the best rate possible. Your credit history and general affordability is crucial in determining this rate. Interest rates vary significantly between lenders, so it's important to compare to give you the best chance of getting the lowest rate and saving the most on interest costs.

3. How is interest calculated on my loan?

Typical Answer: "Interest is calculated using the simple/compound interest method on the outstanding principal balance".
Importance: Understanding how interest is calculated can help you understand how making early payments might reduce the total interest cost. Make sure your car loan contract has a full schedule explaining the total interest costs.

4. Are there any circumstances under which my interest rate could change?

Typical Answer: "Your rate is fixed and won't change throughout the loan term".
Importance: This confirms whether your rate is fixed or variable, impacting your budgeting and financial planning. Car loans are difficult to manage and budget for when the interest rate moves around; fixed rates are the industry standard.

5. What is the total interest cost for different repayment schedules?

Typical Answer: "The total interest you repay will be $X, paid weekly/fortnightly/monthly".
Importance: Understanding the total amount helps you see how the length of your loan and frequency of payments affect the total amount you'll pay over its life.

6. What happens to the interest rate if I experience financial hardship?

Typical Answer: "Make a hardship application; if approved we can change the loan to interest-only repayments, or something to help".
Importance: If your financial situation worsens, you can apply to have your repayments adjusted to avoid default. This option is required under New Zealand law.
Our car loan and hardship application guide has more details about each lender's process.

Car Loan Expert Founder Christopher Walsh offers must-know tips to get your interest rate as low as possible:

"It's time to get real about car loan interest rates. Too many New Zealanders get trapped in high-interest-rate 'deals' that suffocate their finances and ruin lives, as this Stuff.co.nz article from November 2020 explains. Don't let that be you. Here's what you need to do:

Shop Around: Don't just jump at the first loan offer. Shop around and compare rates. A small difference in the rate can save you thousands over the life of your loan.
Negotiate Hard: Walk into that negotiation with confidence. Know your credit profile, understand your worth, and don't be afraid to push for a better rate. Remember, lenders want your business – don't just take the first offer when you're a strong borrower.
Watch Out for 'Bad Credit' Traps: If your credit isn't perfect, don't get hit with an outrageous interest rate. Be wary of lenders targeting those with bad credit with sky-rocketing rates - we think those loans should be illegal. It's often better to wait and improve your credit and affordability than to jump into a predatory loan - they tend to end badly.
Understand the Total Cost: Don't just look at the monthly payment. Calculate the total cost of the loan over its term. Sometimes, a loan with a lower monthly payment can cost you more in the long run.
Educate Yourself: Knowledge is power. Read up, understand the terms, use calculators, and don't hesitate to ask questions. Car Loan Expert is full of these resources - use them to fully understand the loan you're getting into".

Frequently Asked Questions

Does refinancing my car loan to a lower interest rate always save me money?

Not always. While a lower rate reduces monthly payments, refinancing could extend your loan term, leading to more interest paid over time. Also, consider any refinancing fees.

What impact does my credit history have on the interest rate of my car loan?

A higher credit history indicates financial reliability, often resulting in lower interest rates. Lenders view borrowers with a problematic history as higher risk, typically charging them higher rates.

Can I negotiate the interest rate on my car loan?

Yes, it's possible to negotiate. Be prepared with research on current market rates and quotes from other lenders. A good credit history and stable income improve your negotiation power.

What is an interest-only car loan?

In an interest-only loan, your monthly payments only cover the interest on the loan, not the principal amount you borrowed. This means your payments are lower initially, but you're not reducing the actual loan amount.

Such loans usually exist in a case of financial hardship and are not permanent. The main pitfall is that you still owe the entire principal amount at the end of the interest-only period. This can lead to higher payments later or a lump sum payment at the end of the loan term. Essentially, you could end up paying more over the life of the loan compared to a standard amortizing loan.

How do I balance getting a low interest rate with other car loan features?

Finding the right balance between a low interest rate and other loan features is key to choosing the best car loan for your needs. Aspects to consider include:

Loan Flexibility: Sometimes, a slightly higher interest rate might come with benefits like more flexible repayment options or the ability to make extra payments without penalties.
Loan Fees: Don't just focus on the interest rate. Be aware of other fees usually added to the loan, like establishment fees or ongoing account fees, which can add to the overall cost.
Loan Term: A lower interest rate over a longer term might still result in higher overall costs compared to a higher rate over a shorter term. Always calculate the total cost over the life of the loan and compare your options.
Insurance and Add-ons: Some loans with lower interest rates might require (or hard-sell) insurance policies; be careful as often the cover you're buying can be poor value.
Pre-Approval Conditions: If you're offered a low interest rate, check if any conditions are attached, like a larger deposit or the need for a guarantor.

In summary, the goal is to find a loan that has a competitive interest rate and fits your financial situation and needs.