The financial world is waiting for lower interest rates, including those paid to finance new and used cars, SUVs, and pick-ups. The Federal Reserve keeps going up to the line, saying something that sounds like lower bank rates are on the way, but to this point not actually lowering the rates most of us pay to borrow.
Just about everyone in the auto industry is now screaming for lower rates, hoping the Fed announces a September cut. Reduced interest rates mean dealers can carry more inventory and generate more sales, while buyers will enjoy lower monthly costs.
We don’t know if the Fed will lower the Federal Funds Rate in September, the rate banks pay to borrow from one another. But if a rate cut goes through, will it be a .25% drop or .50%? Will there be additional drops in November and December? Several rate declines in a row would significantly reduce buyer costs.
The September meeting is the last scheduled Fed event before the November 5th election. If it lowers rates in September, that will be seen by some as help for Harris.
If nothing happens at the September meeting, that will be seen by others as a boost for Trump. For the Fed, it’s heads you lose, tails you lose, at least to some portion of the population.
Jonathan Smoke, the Chief Economist with Cox Automotive, pointed out in July that average new car interest rates stood at 9.72% while used-car financing averaged 14.2%.
Once the Fed acts, said Smoke, “the average rate on new auto loans is likely to end up between 7.5% and 8%.”
Rates, of course, should also fall for used vehicles. However, lower rates for new or used cars, SUVs, and pick-ups — if they happen — are unlikely to be widespread before year’s end, according to Smoke.
How To Get The Best Auto Financing
Regardless of where rates stand, borrowers should always look for the lowest interest costs and best terms. According to the Consumer Financial Protection Bureau (CFPB), the ultimate rate you receive is likely to be based on several factors.
First, what is your credit score? Higher is better, and best of all is “super prime” scores above 781 or so. Alternatively, a low score can not only mean high monthly costs, it can mean no financing at all.
According to Experian, 29.13% of all auto loans went to super-prime borrowers in the first quarter, while “prime” borrowers — those with credit scores between 661 and 780 — got 37.5% of the auto-financing pie. “Deep subprime” borrowers — individuals with credit scores between 300 and 500 — barely register. They got just 2.19% of the auto loans originated in the first quarter, according to Experian.
Second, how do your income and debts stack up? Vehicle lenders are very interested in your monthly income and the amount of required monthly debt you face, which is known as the debt-to-income ratio (DTI). If the DTI is “too high” the borrower represents excess risk and rates go up.
According to Credit.org, an educational non-profit, a DTI below 36% is ideal, but up to 42% is readily acceptable.
Third, how much is the loan amount? This is a question with some curiosities. If a car is priced at $30,000, then buying with nothing down should mean a $30,000 loan, but maybe not.
After all, the vehicle might come with discounts, rebates, and incentives that can be used for a down payment. And, instead of cash up front, a trade-in might be used as a down payment credit.
In the other direction, it’s possible to have a loan amount that’s greater than the vehicle’s value if you trade in a car with negative equity. This means the value of the trade-in car is worth less than the outstanding loan amount.
According to the Consumer Financial Protection Bureau, “If you’re looking at a $20,000 car and have no money available for a down payment, and have $5,000 remaining on any existing car loan, you need to pay off the unpaid balance before getting a new loan. The dealer may offer to roll the unpaid balance into the new loan, which could create another negative equity situation down the road or make it more difficult to get a new loan.”
There will be a $25,000 loan in this case ($20,000 plus $5,000 in negative equity from the trade-in) for a vehicle worth $20,000. This creates a 125% loan-to-value ratio (LTV). That’s a lot of risk and likely to mean a steep interest rate.
Fourth, how long is the loan term? The longer the loan term, the lower the monthly payment. Since a small monthly payment may be very important to a purchaser, financing with a longer term may be acceptable.
However, it’s also true that the longer the loan term, the greater the interest cost. Example: Borrow $30,000 at 9.5% over 60 months (five years) and the monthly cost is $633.73.
The total interest cost is $8,022. Borrow the same amount with the same interest rate over 84 months (seven years), and the monthly payment will fall to $494.17 while the interest cost will total $11,510.
Fifth, is the vehicle new or used? As we saw from the Cox Automotive figures, new car financing is considerably cheaper than the cost of financing a used car. There are several reasons for this.
New car loans tend to be larger and thus more attractive to lenders. Used cars have more wear and tear and may be well past warranty coverage. Lastly, if the loan is not repaid, it may be harder for the lender to re-sell a used vehicle and get its money back.
Finally, have you shopped around? It makes sense to see what different lenders are offering to better understand the market and your potential financing options. In addition to rates, be sure to check such matters as qualification standards, loan term, right to prepay in whole or in part without penalty, and whether the interest cost is based on a simple interest calculation.