Several economic factors affect the cost of borrowing money to buy a car. Depending on the current condition of the economy, vehicle loan interest rates may rise or fall. Buyers who want to secure the best loan terms must understand the factors that influence these changes.
To make the best financial decision, it’s important to understand how car financing interest rates work. Interest rates play an important role in understanding the cost of borrowing.
Changes in interest rates greatly influence the financing of used cars. For example, when interest rates increase, the monthly payments also go up, making it more expensive to finance a car. Lower interest rates, on the other hand, decrease the total cost and monthly payments, leading to more affordable loans.
Lenders determine interest rates by considering factors such as credit score, market conditions, and loan term. If you have good credit, it is most likely that you will qualify for lower interest rates.
How Interest Rate Changes Affect Used Car Buyers
The Impact of Rising Interest Rates on Car Financing
As interest rates climb, the annual percentage rate (APR) also increases, resulting in higher loan costs. Rising loan costs may incentivize prospective buyers to take out loans, making it more difficult for them to finance the car of their dreams.
Dealerships may experience a decline in sales as buyers grow more hesitant to take out larger loans, especially for expensive cars. Higher rates may further impact car sales since they may make it harder for buyers with lower credit scores to obtain financing.
How Falling Interest Rates Can Benefit Buyers
Buyers can benefit immensely from falling interest rates as they make financing used cars easier and more affordable.
Decreased interest rates indicate lower monthly installments, making expensive used cars more affordable. Furthermore, as less money is spent on interest over the term of the loan, the overall cost of the loan also decreases.
Low interest rates give buyers more flexibility in their budget and car choices, allowing them to pay off their loans much faster. This leads to higher demand for used cars, benefiting both dealerships and buyers.
Monthly Payments vs. Total Loan Costs
Focusing on the monthly installments when buying a car can be tempting. Fitting that sum into your monthly budget is important, after all. However, putting these monthly payments ahead of the car's total cost could be a mistake.
Dealerships often lengthen the loan term to provide a lower monthly payment. While it may seem like a cost that fits your budget, the extended term can actually be costly over time. Focusing on the total cost ensures you're paying a fair price for the vehicle while staying within your budget.
Factors That Influence Interest Rate Changes
Federal Reserve Policies and Economic Conditions
As part of their monetary policy, central banks like the US Federal Reserve modify interest rates. These changes are implemented to control inflation, maintain economic stability, and adapt to shifting market conditions.
Economic conditions have a big impact on interest rates. They are affected by variables like consumer spending, employment levels, and economic growth.
Central banks may lower interest rates during economic downturns to encourage borrowing and spending while raising them during economic growth to avoid overheating.
Credit Scores and Loan Approval Rates
According to consumer credit reporting company Experia, the overall average used car loan interest rate was 11.74% in the third quarter of 2024. The interest rate you receive on an auto loan can vary depending on your credit score.
A high credit score indicates a low likelihood of defaulting on debt. A lender may offer a lower interest rate to reflect the reduced risk involved, as borrowers with high scores are statistically less likely to default.
Now, let's take a look at what you can expect with different credit scores.
- Excellent Credit (750 and above): Lenders see you as a borrower with low risk, allowing you to get a competitive auto loan rate available
- Good Credit (700 – 749): Although you might not get the best rates, you can still benefit from great pricing.
- Fair Credit (650 – 699): You are likely to get high loan interest rates.
- Low or No Credit (Below 650): You are likely to be offered very high interest rates.
Market Demand for Used Cars
The market demand for used cars can indirectly impact interest rate changes. If the demand for used cars is high, dealerships and lenders can offer more financing options to get more buyers. This makes it easier to get a loan. In turn, banks often adjust interest rates to control inflation and excessive borrowing.
On the other hand, a decline in the demand for used vehicles could cause economic activity to taper off, which may lead to a cut in interest rates to incentivize borrowing and consumer spending. As a result, fluctuations in the used car market could affect the decisions regarding interest rate adjustments.
Strategies for Securing the Best Auto Loan Rate
Improving Your Credit Score
A credit score is a key factor in measuring your ability to manage loan payments. A low credit score makes it less likely you'll secure a good auto loan rate, while a high credit score increases your chances of getting a great interest rate and accessing a wider range of loan options.
Here are some steps you can take to improve your credit score.
1. Check your Credit Score Regularly.
Checking your credit score will help you get an idea of what you need to work on.
2. Pay your Bills on Time.
Make sure to pay all your bills on time, including credit card bills, as late payments will seriously lower your credit score.
3. Reduce Credit Card Debt.
Try to settle your credit card debt as quickly as you can, or else it will be a big burden.
4. Keep Old Credit Cards Open.
Keeping old credit cards open can prolong your credit history, which can be beneficial for your credit score.
5. Don't Apply for Too Many New Credit Cards at Once.
Applying for several credit cards could be interpreted as a sign of financial trouble.
Choosing the Right Loan Term
Before selecting a loan term, think about your monthly spending plan and pick one that will enable you to comfortably make regular loan payments without affecting your overall financial situation.
You can choose a shorter term and avoid paying interest if you can afford larger monthly payments. But if not, that's all right! If you get some extra cash, you might be able to make more payments on your auto loan, depending on its terms. By doing this, you can shorten the total term of your auto loan.
It's crucial to keep in mind that cars lose value quickly over time. You should therefore steer clear of a situation in which your car value drops to the point where the loan value surpasses that of the car. To avoid this, choose a loan term that will allow you to repay the loan before the value of the car drops too much.
Comparing Lenders and Negotiating Rates
Examine offers from several lenders, taking note of interest rates, terms, and fees to get the best interest rate on your auto loan. Your loan eligibility will be influenced by your income, credit score, and debt-to-income ratio, so start by creating your budget.
Try to limit your monthly car expenses to no more than 20% of your income, taking into account the entire cost of ownership, which includes gas upkeep and insurance.
Check out online lenders, credit unions, and banks. To secure a rate, apply for preapproval. Before completing your loan, compare used car loan interest rates from at least three lenders to make sure you are getting the best terms.
Having preapproval offers ready when negotiating auto loan rates will show lenders that you are committed to getting the best possible price. Never be scared to request a lower rate, especially if you have offers from other lenders or a high credit score.
Should You Buy Now or Wait for Better Interest Rates?
2025 could be an excellent year to visit your neighborhood dealership if you've been putting off buying a new vehicle.
According to Greg McBride, Chief Financial Analyst at Bankrate, most borrowers should see an improvement in interest rates by 2025; however, those with bad credit might still be stuck with high rates.
You should buy now if:
- You have found a great deal.
- Your credit score is good.
- Interest rates aren't expected to drop soon, and you urgently need a car.
You should wait if:
- Your credit score needs improvement.
- You can afford to delay the purchase.
- Used car prices are high now.
Patience may pay off if you have the financial means to wait and expect better financial circumstances. However, if you find a good offer and need a car right away, locking in a purchase can be a smarter decision.
Making an Informed Decision
Economic changes lead to fluctuations in interest rates. By monitoring essential indicators such as the Fed funds rate and inflation, you can determine the best times to finance a used car purchase. Evaluating different lenders, loan terms, and financing options broadens your chances of getting favorable interest rates.
Final Thoughts
All in all, if you are on a tight budget, reduced monthly payments may seem appealing; however, this typically results in more payments over time and a greater overall cost for the vehicle.
If you want to secure the best price for the car and quickly reduce your debt, you'll have to handle a substantial monthly payment. Using a car finance interest rate calculator can help you estimate your monthly payments and determine the potential interest rate.
Now that you have an understanding of what influences interest rates on used cars, you can better navigate the ups and downs of the auto lending landscape.