How the interest rate on your loan is calculated

Buying a vehicle is a long-term decision and we want to help you make an informed one with our Street Smart series, brought to you by Absa Vehicle and Asset Finance. In this episode, we chat with Absa’s Deen Govender about the factors that play a role in the interest rate that a financial institution will offer you on a loan.

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The cost of living is rising so quickly and so too is the cost of borrowing money. When you apply for a new loan, it’s important to make an informed decision by considering factors that influence the interest rate that is offered. This could help you save a good deal of money throughout the life of the loan.

Deen Govender – Absa Vehicle & Asset Finance’s Head of Dealer Relations for Gauteng and Limpopo – tells us more.

What determines the credit assessment and interest rate?

Absa employs a risk-based pricing approach, where customers’ risk, finance structure and asset characteristics are considered on a deal-by-deal basis.

Therefore, a credit assessment and interest rate are determined by:

A customer’s income, and the sustainability of this income, in order to ascertain and ensure affordability.
Their credit score and credit history. In other words, the manner in which previous credit obligations have been managed.
Depending on the loan, the type and quality of the asset, vehicle or property.
The channel used to buy the vehicle.
The type of interest rate you select when applying for a loan. In other words, whether it is fixed or linked to the prime lending rate.

The choice between a fixed and a variable rate depends on whether a customer is willing to allow market forces to affect their monthly instalments. Generally, the fixed rate option will give one the comfort of an instalment amount that doesn’t change. However, this certainty comes at a cost because the interest rate is typically higher than the variable interest rate, which will increase or decrease in line with the prime lending rate.

Therefore, a customer needs to consider the benefit of the fixed instalment versus the variable instalment and the possible fluctuations that may occur.

Which factors will contribute to having a more favourable outcome on your application for a vehicle-finance loan?

A vehicle with a lower age is less risky for the bank to finance because of the higher value and better warranty, leaving you to focus mostly on maintenance rather than repairs. New vehicles may come at a higher price, but interest rates may be lower because of ongoing car-dealership specials and promotions.
Paying an upfront deposit on the vehicle and borrowing less money. This saves you in the long run, because the interest charged on the loan is lower.
Not taking a large balloon amount – or not taking one at all. It cannot be stressed enough that you need to prepare for this, or you will find yourself making other arrangements such as taking out a personal loan to pay off the balloon amount at the end of the contract term.
Having an existing primary banking relationship with your bank. This makes it easier to assess the recent activity on your account and other credit products.
Having a higher credit score and a longer credit history.

How can you increase your credit score?

You can work towards increasing your credit score by following steps such as:

Paying loans on time and setting up debit orders for payments.
Paying off existing loans, closing any unnecessary accounts and keeping credit use low.
Reviewing your credit score regularly, rectifying mistakes, and identifying any fraudulent activities early.

For extra information on how you can become a better consumer, keep a lookout for more episodes from our Street Smart series and be sure to visit the Absa blog.