Buying a New 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. You'll not only have to contend with higher car prices, but a significant increase in interest rates, too.

Car-loan interest rates increased sharply during the first quarter of 2018, according to Edmunds data. The annual percentage rate (APR) on new financed vehicles averaged 5.7 percent in March 2018, the highest rate since 2009. The Federal Reserve has raised interest rates four times within the past 12 months, and more rate hikes may be on the way.

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 zero-percent loans, Acevedo said. Only 7.4 percent of dealer-financed car loans were zero-percent offers in March, compared to 11.4 percent a year ago. Edmunds attributes this 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 excellent credit, rising interest rates shouldn't have much impact on you. Sure, there may be fewer zero-percent 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 poor credit. When you couple rising vehicle prices with the trend toward longer-term loans, higher rates of interest 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 car costs, 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 $4,487, thanks to more expensive new cars. And loan terms have stretched to nearly six years, an indicator of what people are doing to cope with those rising car costs. While a 1.3-point increase in the average APR is not much by itself, relative to the price of the car (amounting to about $2,102 over the 69.5 months of the loan), an average buyer will pay $6,589 more to buy a vehicle in 2018, once you also take into account costlier cars and longer loans.

The numbers shown above reflect the average in the car-buying market, including the average interest rate of 5.7 percent. But if you have bad or "subprime" credit (roughly, a FICO score of 501-600), you'll easily pay twice the average APR on a new-vehicle loan. This means thousands more in finance charges.

On the 2018 deal shown above, for example, a subprime buyer whose loan has an 11.4 APR would pay $11,501 in finance charges. That's $6,027 more in interest than the average purchaser. In reality, a subprime buyer would not be able to handle a $42,521 car loan (with a $612 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 69 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 interest rates.

If you have good credit:

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 zero-percent interest offers than in the past, it doesn't mean they've dried up completely. If you're willing to keep an open mind about brands and models and 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 heavy incentives have them for a reason: They're not selling that well. For example, SUVs are really popular now, which means that sedans of all sizes are not in demand. 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.

Here are a few vehicles that have zero-percent or low-APR loans in April:
2018 Nissan Altima
2018 Ford Escape
2018 Volkswagen Jetta
2018 Chevrolet Tahoe
2018 Toyota Sienna

If you have poor credit:

1. Consider buying a used car:
The average used-car interest rate is higher than the new-car rate, but has remained relatively stable in the mid-8-percent APR range over the past five years. The rate is much higher for subprime buyers, however, at around 16 percent. But since a used car is generally less expensive than a new one, you're more likely to get financed and still 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. 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 up 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, Before Rates Go Up More?

While the experts forecast an ongoing rise, it doesn't mean you have to buy a car right now. The best 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 the finance conditions have remained more consistent.