Buying a Car When Interest Rates Are High

If you're car shopping and you haven't purchased a vehicle in a few years, you may be in for a shock when you apply for an auto loan. You'll not only have to contend with higher car prices but a significant increase in interest rates, too.

Auto loan rates have increased sharply and are now the highest on record since 2009, according to Edmunds data. The annual percentage rate (APR) averaged about 6.4% for new financed vehicles and 9.5% for used vehicles in March 2019. The Federal Reserve raised interest rates four times in 2018. But that was the worst of it, and no increases are expected for 2019. And while these rising auto loan rates are a sign of a healthy economy, it also means that financing a car will be more expensive.

The move has had far-reaching effects on car buyers in all credit tiers, said Jeremy Acevedo, senior analyst data strategy for Edmunds. And that's not all the bad news.

Carmakers also have cut back on their 0% loans, Acevedo said. Only 4% of dealer-financed car loans were 0% offers in March, compared to 7.6% five years ago. Edmunds attributes the drop to larger automakers shifting to different incentive structures to address slowing sales.

"Many shoppers financing now, compared to just a year ago, can expect to pay hundreds more across the life of their loan — potentially more," Acevedo said.

What This Means for You

If you have a high credit score, rising interest rates shouldn't have much impact on you. Sure, there may be fewer low-rate loans available, but generally, you won't have a problem getting approved or finding a loan with a good rate, even though the rate is likely to be higher than what you had in recent years.

But it's a different story if you have a low credit score. When you couple rising vehicle prices with the trend toward longer-term loans, higher interest rates can make a significant difference in the cost of the loan, as you'll see shortly.

To begin, here's an example of how the changing car market is affecting auto loans, based on Edmunds' average new-car transaction costs and average financing data:

Things have really changed in five years. The average amount financed went up by $4,458 because of the rising cost of new cars. And loan terms have stretched to nearly six years, an indicator of what people are doing to cope with those increasing costs. While a 2-point increase in the average APR may not seem like much at first glance, when you add up the total finance charges, an average buyer will pay $7,307 more to finance a vehicle in 2019.

The numbers shown above reflect the average in the car-buying market, including the average interest rate of 6.4%. But if you have bad or "subprime" credit — roughly, a FICO credit score of 501-600 — you could easily pay twice the average APR on a new vehicle loan, which means thousands more in finance charges.

On the deal shown above, for example, a subprime buyer whose car loan has a 12.8% APR would pay $13,482 in finance charges. That's $7,099 more in interest than the average purchaser. In reality, a subprime buyer would not be able to handle a $45,443 car loan, with a $653 monthly payment, and would likely opt for a cheaper new car or a much less expensive used one.

Here's a general rule to apply to your own credit situation: On a $30,000 vehicle financed for 72 months, financing charges will rise roughly $1,000 for every percentage point increase in the loan.

What You Can Do

Here are a few ways to manage rising auto loan rates.

If you have a high credit score:

1. Consider leasing: Interest rate hikes do affect leasing, but since the total lease amount is a fraction of a new car's sale price, you will still pay less every month. Edmunds'leasing advice remains the same regardless of interest rates: Look for lease specials, keep the down payment low, and be mindful of the mileage limits.

2. Find a car that has a low APR offer: While there are far fewer 0% interest offers than in the past, it doesn't mean they've dried up completely. Plus, there are still a number of low APR deals for 1.9% or 2.9%. If you're willing to keep an open mind about brands and models as well as consider cars that you might not be familiar with, you can still get a great financing deal.

That said, it's important to keep in mind that models with heavyincentives have them for a reason: They're not selling that well. Choosing a car with a hefty incentive may make sense now, but keep in mind that when you want to sell or trade in, the vehicle's resale value may reflect its lack of popularity.

If you have a low credit score:

1. Consider buying a used car: The average used-car interest rate is higher than the new-car rate, but since a used car is generally less expensive than a new one, you're more likely to get financed and have a lower monthly payment than if you bought new. Just be mindful of the length of the car loan: An 84-month loan on a used car means you could have a very out-of-date vehicle on your hands by the time you pay it off.

2. Get preapprovals from other lenders: This advice applies to those with either a high or low credit score. Take the time to get preapproved by other lenders before you head to the dealership. It will give you a better idea of what the total loan amount will be and also give you a basis to compare the interest rates that the dealership's lenders may offer.

3. Fix up your car while you fix up your credit: In some cases, the best thing to do may be to maintain your current vehicle while you work on your finances. If you can keep your vehicle running for another year or so, it will allow you to save more for a bigger down payment, which will whittle down the amount you need to finance. You also can use the time to work on improving your credit. Run a copy of your credit report to see which items need attention. In general, you'll want to pay off debt with the highest finance charges first.

Buy Now or Wait for the Rates to Drop?

The experts forecast some stability for the coming year, so things won't get dramatically worse. If you were hoping for rates to drop, it could take another year or so. With this in mind, thebest time to buy a car often depends on the model you want and how long it's been out, rather than the interest rates available at the moment. If you need a car now, use our tips to minimize the impact on your wallet or shop used, where prices should be lower. And if interest rates have improved in a year or two, you can always refinance a loan to bring down your payment and total loan amount.