Securing a competitive auto loan interest rate is crucial for saving money over the course of your loan. In this guide, we’ll explore six key factors that influence auto loan interest rates, giving you the information you need to get the best deal. We'll back up each point with data to help you understand how these factors play out in real-life scenarios.
1. Credit Score: The Most Important Factor in Auto Loan Rates
This might come obvious for some, but your credit score is the top factor lenders use to determine your auto loan interest rate. A higher credit score generally means you’re seen as a lower risk to lenders, which results in a lower interest rate. In contrast, a lower credit score signals higher risk, which often leads to increased interest rates. However, even if you have a high credit score there are other factors that could stop you from getting a loan. Either you don't have much loan history, your FICO Auto Score could be completely different and show lower scores due to many factors. Interested in learning what a FICO Auto Score is? Read our blog on What is FICO Auto Score? Learn How It Affects Your Loan
According to a 2023 study by Experian, the average auto loan interest rate for borrowers with excellent credit (781-850) is around 5.18-6.79% for a new car loan. For those with fair credit (601-660), the average interest rate jumps to 8.86-13.28%, while subprime borrowers (500-600) face rates as high as 11.53-18.55% on average for a new car loan.
This means that improving your credit score could save you thousands of dollars over the life of your loan. For example, if you borrow $25,000 for a car at a 4.75% interest rate, your total interest cost would be around $3,000 over five years. But at a 14.39% rate, you could pay over $10,000 in interest alone.
2. Loan Term: Why Longer Auto Loan Terms Lead to Higher Interest Rates
Loan terms—the length of time you agree to repay your loan—directly affect your auto loan interest rate. Shorter loan terms (such as 36 or 48 months) often have lower interest rates, while longer terms (72 or 84 months) come with higher rates. This is because the lender faces more risk over a longer period of time and compensates by charging higher interest.
A 2024 report from Edmunds revealed that the average interest rate for a 36-month new car loan was 3.73%, while the rate for a 72-month loan climbed to 8.1%. Even though longer loan terms result in lower monthly payments, the overall cost of the loan can be much higher. For instance, a $25,000 loan at 8.1% for 72 months costs over $5,647 more in interest compared to a shorter 36-month loan at 4.73%.
While long-term loans may be appealing for their lower monthly payments, you’ll pay significantly more in interest. Consider opting for the shortest loan term you can afford to minimize overall costs. However, don't stress over this too much. If you know you can't afford a shorter loan term, then don't force yourself into a shorter loan term!
3. Down Payment: How a Larger Down Payment Can Lower Your Interest Rate
Making a larger down payment can reduce your auto loan interest rate. When you put down a substantial amount upfront, you lower the total amount you need to finance, which reduces the lender's risk. A general rule of thumb is to aim for a down payment of at least 20% for new cars and 10% for used.
According to Kelley Blue Book, the average car price in the U.S. in 2023 is around $48,000 for a new car. If you put down 20% ($9,600), you would finance $38,400. Reducing the financed amount also reduces interest. For example, on a $38,400 loan at 5%, the interest over five years is approximately $5,071. Without a down payment, financing the full $48,000 could result in $6,336 in interest—over $1,200 more.
Not only does a larger down payment reduce the total interest paid, but it also can improve your loan-to-value ratio (LTV), which can lower your interest rate further. Additionally, a larger down payment can help you avoid owing more than the car is worth—an issue known as negative equity.
4. Vehicle Age: New vs. Used Car Auto Loan Interest Rates
Whether you’re buying a new or used car has a significant impact on your auto loan interest rate. New cars typically come with lower interest rates because they’re less risky for lenders—they depreciate less rapidly and are less likely to have mechanical issues early on.
According to the National Automobile Dealers Association (NADA), the average interest rate for a new car loan in 2023 is about 5.16%, while the average rate for a used car loan is 8.84%. This difference is because used cars are more likely to have issues that could lead to the buyer defaulting on the loan.
Additionally, depreciation plays a large role. New cars lose about 20% of their value within the first year, while used cars have already gone through this initial steep depreciation. This adds a layer of risk to the lender when financing a used car, hence the higher rates. However it may be financially a good option to get a used car. Just make sure you look the car over and make sure it has no major problems.
5. Economic Conditions: How Market Trends Influence Auto Loan Interest Rates
The overall state of the economy plays a big role in determining auto loan interest rates. Interest rates fluctuate based on factors like inflation, unemployment, and Federal Reserve actions. When the economy is strong, and the Federal Reserve raises interest rates to prevent inflation, auto loan rates typically rise. Conversely, when the Fed lowers rates to stimulate the economy, auto loan rates may drop.
The Federal Reserve’s benchmark interest rate influences all types of loans, including auto loans. For example, in 2023, when the Fed raised interest rates to combat inflation, auto loan rates surged from an average of 4.75% to nearly 6.58% over the course of the year. This trend is expected to continue as the Fed adjusts to global economic conditions.
Consumers can take advantage of lower interest rates during periods of economic downturn or when the Fed announces rate cuts. Timing your car purchase to align with these trends can save you hundreds or even thousands over the life of the loan.
6. Lender Type: Comparing Auto Loan Interest Rates from Banks, Credit Unions, and Dealerships
Where you get your auto loan can have a substantial impact on the interest rate you receive. Banks, credit unions, and dealerships all offer auto loans, but their rates can vary significantly. Credit unions are known for offering some of the lowest auto loan rates, typically because they are not-for-profit and pass savings onto their members. Banks, on the other hand, may have higher rates due to profit margins, and dealership financing often includes a markup for the dealership’s services.
In 2023, the average auto loan rate from credit unions hovered around 4.45%, while banks charged closer to 5.24%. Dealership financing can range even higher, with some dealers charging interest rates up to 8% or more, especially if they add dealer markups. By shopping around, you can compare these different options and potentially save hundreds in interest over the course of your loan. Check out our blog on Auto Loan Pre Approval: What You Need To Know to find out more on how to shop around for the best loan rates.
According to a study by the Consumer Financial Protection Bureau, borrowers who shopped around for their auto loan saved an average of $1,200 over the life of the loan. It’s always a good idea to get pre-approved from a bank or credit union before visiting the dealership, so you have more negotiating power.
Understanding Auto Loan Interest Rates to Save Money
Auto loan interest rates can vary greatly based on several factors, including your credit score, loan term, down payment, vehicle age, economic conditions, and lender type. By understanding how each of these factors affects your rate, you can make more informed decisions and potentially save thousands of dollars over the life of your loan.
Pro Tip: Before committing to a loan, take the time to check your credit score and shop around for the best rates. You can also read our Step-by-Step Guide to Applying for an Auto Loan for more tips on securing the best financing options and our Auto Loan Pre-Approval Guide to understand the pre-approval process.
Comments