The ideal situation for buying a car is still paying in cash and in full. (Whatever you do, never lease a car if you can avoid it.) But with both interest rates and list prices continuing at such great heights, most buyers feel they are left with one option: Getting an auto loan.
Unfortunately, the numbers aren’t pretty on the loan front, which means finding a new car in your budget is no easy feat. With car prices still at a high compared to recent years, it might be tempting to get a long loan to minimize the monthly payments. However, as loan interest rates have risen above 6.5% on average, you’d be locking in high interest for many years that will squeeze a lot more money out of you by the end than you may realize.
Here’s what to know about how higher interest rates have made buying a car such a challenge these days, and what you can do if you absolutely need to buy a car right now.
How high interest rates impact car loans
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In short, there’s never been a worse time to buy a car. The average new car loan has a monthly payment over $750, with an interest rate of 9.5%, according to the Wall Street Journal. For used cars, that number shoots up to above 13.7%. And how long are you stuck with these exorbitant payments? According to data from Experian, the average term for loans is nearly six years. And with a long six-year loan, you’ll pay significantly more in interest than just a couple of years ago.
Plus, car prices remain inflated well above pre-pandemic levels. Even with prices cooling slightly, inflated prices plus high interest mean you’ll end up paying far above sticker price over a lengthy loan term.
Long loans keep you underwater
Long loans also mean you’re more likely to end up owing more on the car than it’s worth if you want to trade it in a few years, as depreciation outpaces the loan balance. Even if you finance 100% of a car’s value, higher rates mean you’re more likely to end up owing more than it’s worth if you want to sell or trade it in later. This creates a tough situation when you want to get your next car.
Let’s take a look at how as interest rates rise, your monthly car payment will be higher for the same priced vehicle. For instance, A $25,000 car with a 5% rate over five years would have a monthly payment around $460. At a 7% rate, the payment jumps to $495.
In the same vein, higher interest rates mean you pay more overall for the same car. That $25,000 car at 5% interest over five years ends up costing about $27,600 total with interest. At 7% interest, the total cost is $29,700, leaving you to cough up an extra $2,100 in interest paid.
What you can do instead
If you’re in the market for a new or used car, it can feel there’s no good (read: cheap) way forward. Still, some financing options are better than others.
- Consider buying used or waiting. Pre-owned cars don’t face the same supply shortages and have depreciated substantially already. Or, if possible, try waiting out the shortages and price spikes entirely until supply rebounds.
- Make a large down payment. Putting 20% or more down reduces the amount you have to finance, lowering the interest charges. Plus, it helps guard against being underwater on the loan.
- Get the shortest term possible. Opt for a three- to four-year loan if you can manage the higher payments. This prevents getting stuck paying interest on a deflating asset for close to a decade.
- Shop around for lower rates. Check rates at credit unions and local banks and negotiate hard with dealers to get the lowest possible APR. Even small differences can save thousands over the life of the loan.
The bottom line is that high interest rates translate to larger car payments and higher overall costs. Do your best to buy smart, make a solid down payment, and shorten the repayment term to avoid major pitfalls. But in the end, it may be better to wait for rates to settle down or buy a less expensive used car in cash, if possible.