Rising interest rates affect nearly every aspect of the economy, from the price of eggs to mortgage payments. The Federal Reserve again refrained from raising the federal funds rate at its June meeting, but interest rates have been raised a total of 11 times during this economic cycle.
With the summer car-buying season fast approaching, it's wise to understand how these rising interest rates will affect the price you'll pay when purchasing a new vehicle. Is it better to wait until interest rates drop, or is this the new normal that car buyers will have to accept? And if you choose to wait, how long will you have to wait?
We sat down with Greg McBride, chief financial analyst at Bankrate, to explore these questions.
Interest rates are unlikely to fall this year
Simply put, interest rates aren't expected to fall this year. This is mainly due to the Federal Reserve's ongoing efforts to keep inflation in check. However, rising interest rates aren't the only factor that will cause auto loan rates to rise this year.
“Higher interest rates mean higher borrowing costs, which acts as a brake on the economy for car buyers,” McBride explains. “Rising interest rates are another factor that makes buying and financing a car more expensive.”
McBride points to the rise in auto prices that has coincided with a sharp rise in interest rates: The average car price rose slightly in October, pushing the average price of a new car to just over $48,200, according to Kelley Blue Book. And more expensive cars are also more expensive for borrowers to finance.
As you can see below, interest rates for both new and used cars have been steadily increasing since the pandemic began in 2020.
So, is now a good time to get a car loan?
The answer depends on your needs. If you have a car in your garage that can get you from point A to point B, it may be wise to stick with what you have. But if you need a car, be prepared to spend more on financing, especially if you have bad credit.
Borrowers with poor credit may have a hard time finding competitive interest rates.
The Fed's action doesn't affect the interest rate you receive when purchasing a car, but it affects the costs to lenders who fund your purchase. These costs are passed on to borrowers, causing lenders to tighten their lending standards. With the federal funds rate increasing 11-fold since the beginning of 2022, borrowers will feel the domino effect.
Those most disproportionately affected are those with poor credit histories, McBride explains.
“Not only will interest rates remain higher, but your borrowing capacity and the amount you'll be approved for may also change as the year progresses,” he says.
Borrowers who fall into the deep subprime category of 300-500 can expect interest rates of more than 14% on new loans and more than 21% on used loans, according to Experian's third-quarter 2023 averages.
Unlike borrowers with good credit, borrowers with poor credit don’t have the power to find the best interest rates available.
Bankrate Tips
If you are looking for a car loan with bad credit, consider securing the loan with the help of a co-signer to benefit from better interest rates.
Rising prices hit wallets harder than interest rates
While rising interest rates are directly influenced by the choices made by the Federal Open Market Committee, they are not the only factor burdening consumers.
What has really gone up are car prices, McBride said. “The impact of rising interest rates is negligible in comparison.”
Interest rates are rising at the fastest pace in 40 years, but the real problem is soaring auto prices, which soared during the pandemic and have stayed high. Auto prices have stabilized, but high interest rates wipe out any real gains.
“The good news for consumers is that auto loan rates may not get worse, despite the Fed's threat of further rate hikes,” explained Jonathan Smoak in a recent Cox Automotive report.
“The interest rates consumers pay on auto loans are driven more by bond yields and yield spreads than by the federal funds rate,” he noted.
Fortunately for drivers, Smoak believes these two factors are already peaking due to the tightening of credit caused by the banking crisis.
Additionally, wholesale vehicle prices have fallen in the spring, which could make this summer cheaper for used-car buyers. With more cars on the lot, there's also less competition to secure your dream car.
Bankrate Tips
Buying a used car instead of a new one can help you save money while still enjoying the benefits of buying a new car.
How to get the best car loan deal
There may be times when you need to buy a car even in a bad economy, and if that happens, try these tips to help you get a good deal.
Shop around: While most lender options now offer similar interest rates, it's still important to shop around and find the best rate you can secure. Paying close attention to any extra fees a lender may impose can save you extra money. Find the true cost of ownership: The cost of owning a car goes beyond just your monthly car payment. Instead, take the time to calculate the true total cost, which covers aspects like trips to fill up with gas and maintenance along the way. Lock in your expected interest rate: If your lender offers it, applying for loan pre-approval will let you know exactly how much you'll need to pay each month. Consider driving an EV: Aside from the obvious environmental benefits, driving an electric vehicle can reduce costs over the life of ownership. EV incentives can also help you save money.
But the best way to ensure you're competitive when it comes to auto loan financing is to make sure your credit is in tip-top shape, McBride advises. A high credit score can make it easier to get approved for a loan and can also give you perks like lower interest rates, he explains.
Next steps
While it's hard to make predictions without a crystal ball, experts believe interest rates are unlikely to fall anytime soon. With that in mind, use this time to improve your credit score so you can benefit from the most competitive interest rates available, whatever they may be.