Vehicles are expensive, and that means you may not be able to pay the sticker price up front. Instead, you may be looking into car loans as a way to help you spread the cost of the vehicle over a number of years. Factored into the monthly loan repayment is an amount of interest. The rate varies from person to person, depending on how much you're borrowing and your personal credit score. Some states limit the amount of interest that lenders are allowed to charge, but the cap doesn't always apply to car finance companies.
Your state's usury laws determine the maximum interest rate that a lender is permitted to charge. This could be anywhere from 5 to 24 percent, depending on where you live. However, the rules are complex and the rate caps don't always apply to car loans.
How Do Auto Loans Work?
When you take out an auto loan, the lender buys the car for you and you pay the money back in installments over a set number of years. Essentially, the lender is giving you the right to use its money. In return, you agree to pay the lender a predetermined rate of interest. This is how the lender earns a profit on the loan.
Most auto loans use simple interest, which means the interest is calculated only on the amount you borrow with no compounding. This can save you a lot of money over the life of the loan.
What's the Interest Rate on an Auto Loan?
The interest rate is set by the lender and it depends on many things, including the bank's policy and market factors such as what other lenders are charging for their loans. On the customer side, the lender will look at your repayment history and credit score to determine how creditworthy you are. Lenders tend to offer their best rates to the most creditworthy customers who have a very high likelihood of paying back the loan in full and on time.
Generally, the “right” credit score depends on whether you’re buying a new or used car and the lender you’re interested in. According to the consumer credit reporting agency Experian, buyers in the market for new car financing had an average score of 722 in 2017. For used cars, the average credit score dropped to 682. However, a bunch of loans will go to borrowers with credit scores below those figures; it depends how much the car dealer wants to sell the car to you.
Since the interest charge represents the lender's profit, it's fair to say that most lenders will charge the maximum rate they think you will pay. For most people, cars are indispensable – you need one to get to and from your job and wherever else you need to go. If your credit is weak, then you may have slim pickings when shopping for loans. Auto lenders know this, and that is why they fix the highest rate they can get away with.
What's the Highest Legal Interest Rate for a Car Loan?
The good news for consumers is, lenders cannot charge more for car loans than the law allows them to charge. The act of charging an excessive amount of interest is known as "usury." Laws that restrict the amount of interest a lender can charge to consumers are known as "usury laws" and these laws are on the books, in some form or another, in all 50 states.
Currently, there are no federal regulations regarding usury. To find out if a usury rate cap affects your finance agreement, you're going to have to research the maximum interest rate by state for auto loans in your jurisdiction.
Usury is Complicated
Frustratingly for consumers, it's not as simple as typing "maximum interest rate for (your state)" into a search engine. Some states apply the same usury rate to all loan types, whether it's an auto loan from a car finance company or a personal loan between friends. Other states have different rates depending on whether the loan is a consumer loan, educational loan, business loan, written loan, oral loan and so on. Some states do not apply usury laws to car loans at all.
The amount of the loan can make a difference too, with some states establishing a different usury rate for, say, a $2,000 loan than for a $1 million loan. The rates themselves can also change periodically.
Thus, the information that follows is only a guide to give you some idea of the type of interest rate ceilings we're talking about. You should always consult the state government for the current usury law (if any) affecting your particular auto loan.
Usury Rates By State 2018
At the time of publication, the general state usury limits are as set out below. Note that some states have different rates for loan contracts where a rate is written into the contract, versus a general loan agreement where no rate is specified. Since most auto finance loan rates will be written into a contract, we've given you the written rate.
5 percent: Iowa, Michigan, Wisconsin
6 percent: Alabama, Maine, Maryland, Massachusetts, Minnesota, North Dakota, Oklahoma, Pennsylvania, Texas
7 percent: California, Wyoming
8 percent: Kentucky, Mississippi, North Carolina, Ohio, Virginia, West Virginia
8.75 percent: South Carolina
9 percent: Missouri, Oregon
10 percent: Arizona, Hawaii, Kansas (Kansas can rise to 15 percent by mutual agreement), New Hampshire, Tennessee, Utah
10.5 percent: Alaska
12 percent: Colorado, Connecticut, Idaho, Louisiana, Rhode Island, Vermont, Washington
15 percent: Montana, New Mexico, South Dakota
16 percent: Nebraska, New Jersey, New York, Georgia (for written loans for less than $3,000; there's no limit in Georgia for loans between $3,000 and $250,000)
17 percent: Arkansas
21 percent: Indiana
Some states have fluctuating rates. The usury rate for Delaware is 5 percent over the Federal Reserve discount rate from time to time. In Nevada, the rate is the prime rate of the largest Nevada bank plus 2 percent. Florida determines the rate yearly; Illinois determines the rate periodically. The District of Columbia has its own rate of 24 percent.
Who the Lender is Matters
To appreciate the complexity of usury laws, understand that usury rates affect different lenders differently. Usury laws have no effect on most banks, which operate under separate rules. So if you arrange a car loan with a bank, you may get a completely different rate than if you arranged the loan with a car financing company.
Licensed lending institutions that engage in the business of making consumer loans – a category that includes auto finance companies – are often exempt from the state's usury laws. In California, for example, usury does not apply to consumer finance companies. In other words, auto lenders in California do not have to abide by the state's 7 percent interest rate ceiling and can quote you a higher rate.
Another thing to watch out for is where the finance company is incorporated. Lenders may be able to circumvent a restrictive usury rate by basing their rate on the state in which the lender is incorporated, rather than the state where the car buyer lives. For instance, if you live in Michigan you may be expecting a rate no higher than 5 percent. But if the finance company is incorporated in Indiana, then you could be looking at a rate up to 21 percent.
What If I Need a Car Loan at any Rate?
Some people find themselves paying a usurious interest rate on their auto loan because they don't know there are caps in place to protect them. Others agree to pay a usurious rate voluntarily because it's the only way they can get a loan. If you're begging and pleading to pay a higher rate so you can get the car you desperately need, then understand that some jurisdictions let you waive the interest rate cap when you apply for financing. This will override the legal protections of the usury laws.
Most lenders will ask you to sign a waiver declaration if you go down this route. That's protection for them if you ever try to mount a usury claim in the future.
What Happens if a Rate is Deemed Usurious?
If you've inadvertently signed a loan with an illegal interest rate, then you may have a number of remedies available to you. Generally, you can sue the lender for money damages. In some states, you can sue for the extra interest you've paid above the legal amount. Other states let you claim back all the interest you paid over a specific period and not just the usurious amount. And others still let you claim back double or even triple the amount of usurious interest – it depends on where you live.
North Dakota, for instance, has some of the harshest penalties in the country. If the lender screws up, it must pay you back twice the amount of interest as well as 25 percent of the principal amount of the loan. The lender also forfeits interest for the rest of the loan term, which basically takes away all the lender's profit.
In some cases, if the lender acted maliciously or fraudulently, you may be able to recover punitive damages. These damages are not connected to your loss but are awarded to punish the lender. The lender may also be liable for criminal penalties. These are pretty stiff in some states, amounting to imprisonment and six-figure fines.
You Still have to Pay the Principal
Even if you win a usury lawsuit, understand that the loan itself will not be written off. The lender has bought a vehicle for you, and it will always be entitled to receive the principal loan amount back. Most auto loans are secured against the car, so if you don't pay back the principal, the lender could repossess your vehicle. It's important that you keep up your payments unless a court tells you not to.
The Bottom Line
Summing all of this up, here's how interest charges work for auto loans:
- Lenders can charge any rate they like, based on your credit score, unless your state restricts the amount of interest they can charge
- The maximum rate depends on the loan amount, loan type and whether the loan rate is written into a contract
- Banks and finance companies are often excluded from the rules so chances are your auto loan is not protected
- If usury laws do apply and your loan rate is deemed to be usurious, you can get back the interest you paid
- You still have to pay back the loan principal, no matter what the situation is regarding the interest payment.
As you can see, this is an extremely complex area of law. If you think your loan has an excessive interest rate, or if you wish to challenge a usurious loan, then it's critical that you take advice from a legal professional.
- Usury - National Consumer Law Center
- Find Law: State Interest Rate Laws
- Berkowitz, Pollack, Brant: Is Your Loan in Violation of State Usury Laws?
- Gehres Law Group: What you Should Know Before Lending or Borrowing Money
- Upcounsel: State Interest Rates and Usury Limits: What You Need to Know
- Finder: What Credit Score do I Need to Buy a Car?
Jayne Thompson earned an LLB in Law and Business Administration from the University of Birmingham and an LLM in International Law from the University of East London. She practiced in various “big law” firms before launching a career as a commercial writer. Her work has appeared on numerous financial blogs including Wealth Soup and Synchrony. Find her at www.whiterosecopywriting.com.