Why Are Car Loans So High and What's Behind the High Interest Rates

Car loans have become a necessary evil for many of us, but have you ever wondered why they're so high? According to the data, the average car loan amount in the US has been steadily increasing over the years, with a whopping 72% of new car buyers financing their purchase in 2020.

This shift towards financing has led to a significant increase in car loan debt, with the total outstanding balance reaching $1.4 trillion in 2020. That's a staggering number, and it's no wonder why car loans are so high.

The high interest rates associated with car loans are also a major contributor to their overall cost. In fact, the average interest rate on a new car loan in 2020 was 5.1%, which is significantly higher than the interest rates offered on other types of loans.

Car loans are high because lenders are taking on more risk than ever before. This is due in part to the fact that many borrowers are now using their home equity as collateral to secure their car loans.

In the past, lenders were more selective about who they lent to, but today they're often willing to lend to people with lower credit scores. This is because they can charge higher interest rates to compensate for the increased risk.

The average interest rate on a new car loan is around 6%, which is significantly higher than the interest rates offered on other types of loans.

New vs used cars have different loan options, with new cars typically having lower interest rates. This is because lenders can more easily estimate the value of a new car and its demand on the market.

New cars are also generally more reliable and less likely to break down, reducing the risk of default.

Loans for used cars, on the other hand, often come with higher interest rates. This increased interest rate helps offset the uncertainty of accurately estimating a used car's value and demand.

The lender's ability to sell the car and recoup its costs if the borrower falls behind on payments is also a factor in the higher interest rates for used cars.

In this article, we'll explore the reasons behind high car loan interest rates. We'll discuss what factors influence these rates and provide tips on how to lower them.

Shopping around for car loans is a great way to find a good deal. You can compare offers from different lenders to get an idea of what rate to expect.

Factors that influence car loan interest rates include your credit score, loan term, and the type of vehicle you're purchasing. Knowing these factors can help you understand why your interest rate is high.

Here are some key points to consider:

Car loan interest rates can be influenced by several factors, with creditworthiness being the most significant one. Borrowers with strong credit scores, typically above 670, usually qualify for lower interest rates.

Your credit score plays a crucial role in determining the interest rate you receive, with lenders considering it a key indicator of your likelihood to make timely payments. A good credit score can save you money in interest over the life of the loan.

Interest rates can also vary based on the type of car you're buying, with new cars generally having lower rates than used cars. For instance, in Q2 2024, the average APR for new cars was 6.84%, while used cars had an average APR of 12.01%.

Here are the average interest rates for borrowers based on credit score range and type of car loan:

The length of the loan term can also impact interest rates, with shorter-term loans generally having lower rates than longer-term loans. Borrowers who opt for shorter-term loans, typically up to 60 months, may be able to secure better interest rates.

Auto loan rates have been on the rise, and it's no surprise that many drivers are falling behind. The average interest rate for new car loans is a whopping 6.84%, while used car loans are even higher at 12.01%.

Creditworthiness plays a huge role in determining the interest rate you'll receive. Borrowers with strong credit scores, typically above 781, can qualify for lower interest rates, often around 5.25% for new car loans.

On the other hand, people with low credit scores may receive much higher rates. For example, borrowers with a credit score between 501 and 600 can expect to pay around 13.18% interest on a new car loan.

The type of car loan also affects the interest rate. New car loans tend to have lower interest rates than used car loans. For instance, a superprime borrower (781-850 credit score) can expect to pay 5.25% interest on a new car loan, but 7.13% on a used car loan.

Here's a breakdown of average interest rates by credit score range:

It's essential to understand that these interest rates are averages, and your actual rate may vary depending on your individual circumstances.

Your credit score plays a huge role in determining whether you qualify for a car loan and the interest rate you receive. Borrowers with good to excellent credit, generally a score of 670 to 850, usually receive the best interest rates.

Lenders see these borrowers as more likely to make all of their monthly payments on time and pay off the loan as agreed. Borrowers with poor credit, on the other hand, are at a higher risk of defaulting, which is why they often receive the highest interest rates.

Car buying decisions often involve a significant amount of research and consideration. Many car buyers are influenced by factors such as fuel efficiency, maintenance costs, and safety features.

A study found that 75% of car buyers consider fuel efficiency when making a purchase, with electric and hybrid vehicles becoming increasingly popular.

The average car buyer also spends around 60 hours researching and comparing different models before making a decision.

Underwater trade-ins are bumping up payments, with 23% of customers having negative equity of more than $6,167 on average in the first quarter.

This is a record amount, and it's not just a little bit of negative equity either. About one-third of trade-ins carried negative equity prior to the pandemic.

Trading in a vehicle with negative equity means the consumer rolls that balance owed into the new auto loan, resulting in higher payments with higher interest rates for longer periods.

The average payment with a trade-in was $736, but with negative equity, it jumps to $887. And the interest rate? 8.1%, compared to 7.1% without negative equity.

You're paying off a car from 10 or 15 years ago, and you've never actually paid off a vehicle. That means you're constantly paying for something you don't even own anymore.

If you're in the market for a new set of wheels, you should know that the average cost of a new car in the US is around $33,000.

Before you start browsing, consider your budget and how much you can afford to spend on a car each month. In the article, we discussed how a good rule of thumb is to spend no more than 20% of your take-home pay on car payments.

You'll also want to think about the type of car you need. If you have a big family, a minivan or SUV might be the way to go. Research has shown that these types of vehicles are often preferred by families with multiple children.

Consider the fuel efficiency of the car you're interested in, especially if you plan on driving long distances. A car with a fuel economy of at least 25 miles per gallon can save you money on gas in the long run.

Don't forget to factor in the cost of maintenance and repairs when calculating the total cost of ownership. According to the article, a study found that the average car owner spends around $1,300 per year on maintenance and repairs.

Car buyers can expect some pricing relief, with incentives rising by 81% over the past year, according to Moody's.

This relief may come in the form of straightforward discounts, interest rate subvention, or trade-in allowances. However, the timing of Federal Reserve interest rate changes is uncertain.

The Federal Reserve doesn't directly determine auto loan rates, but its influence on federal funds rates trickles down to bank loan rates, including car loans.

Making a larger down payment on a car loan can have a significant impact on your financial situation. This is because it shrinks the amount you borrow, which lowers your monthly payments and interest costs.

A larger down payment also helps reduce your interest rate because you're borrowing less. This is because lenders view larger down payments as a lower risk, which can result in lower interest rates.

Lowering your interest rate can save you money over the life of the loan. For example, making a larger down payment can help you qualify for a lower interest rate, which can shave off hundreds or even thousands of dollars from your total interest paid.

Car buyers may see pricing relief, as incentives have risen by 81% over the past year, according to Moody's.

Incentives can take various forms, including cash discounts, interest rate subvention, and trade-in allowances.

A straightforward discount on a car is sometimes called "cash on the hood", where the dealer gives a customer a discount on the sticker price.

Interest rate subvention can provide 0% interest for a certain number of months, making car payments more manageable.

Trade-in allowances can offer an above-market price on a trade-in, which can be a significant incentive for buyers.

However, the Federal Reserve's decision to lower interest rates is uncertain, and even when it does, there's a six-month lag before changes show up in auto loan rates.

Inflation has pushed vehicle sticker prices higher, making it harder for buyers to get relief in the actual interest rate.

The manufacturers can lower interest rates artificially using incentives, but real relief in the actual interest rate isn't going to come until after this year.

This means that the relief buyers may see in the short term may be short-lived, and prices may remain high for years to come.