With Used Car Prices Up 27%, Here’s How To Find An Affordable Auto Loan

Car shopping comes with sticker shock these days, with new car prices up 5% year-over-year, and used car prices up 27%, according to data from Edmunds.

But the car’s price isn’t the only thing that impacts its affordability: if you plan on borrowing, the interest rate and terms on your car loan matter too. Not everyone thinks to negotiate for a good deal on their auto loan, or even realizes they can negotiate.

Because the average sales price of a new car is now over $40,000, and the average term of an auto loan is stretching out, now 70.6 months, a one percentage point change in your loan’s interest rate would be expected to save you about $1,200 over the course of your loan.

Here are three steps to make sure you get the best deal possible on your auto loan.

Check Your Credit Reports, and Clear Up Any Errors

When you apply for an auto loan, lenders will typically check your credit history by reviewing your credit report from one or multiple of the three major credit bureaus: Experian, Equifax
EFX
, and Transunion
TRU
.

Americans can get a free copy of their credit reports from these credit bureaus once a year from AnnualCreditReport.com, a website established by the federal government.

Clearing up any mistakes that appear on your credit report can help reduce the likelihood that you’ll be overcharged for your auto loan. Some common errors are duplicate information (like a bill in collections, or a loan application that mistakenly appears multiple times), medical billing errors, and credit report mix-ups, where data about someone with a similar name is mistakenly added to your credit report.

The free copies of your credit report you can get from AnnualCreditReport.com will show information that lenders will consider about your financial history, like the amount of your debts, your payment history, and any bills in collection. Those credit reports, however, don’t show you your FICO credit score: some banks, including American Express
AXP
, Citibank and Bank of America
BAC
, offer free FICO credit scores as a service for some or all of their accountholders, and Discover
DISCA
offers free FICO credit scores even for non-customers.  

Know the Typical Interest Rates For Your Credit Score

If you know the typical interest rate, or APR, that others with your credit score typically receive from auto lenders, you’re less likely to get fleeced.

Car interest rates were very low from 2015 until 2017 – the average rate on 60-month auto loans was around 4%, and some customers with good credit scores received zero interest rate loans. Average interest rates have risen somewhat since then: the average rate on a 60-month auto loan was 5.05% in May 2021, according to data from the Federal Reserve.

For used cars, which typically come with higher interest rates than new cars, consumers with a FICO score above 781 should look for interest rates under 4%. Consumers with a credit score between 661 and 780 should look for an interest rate under 6%. And consumers with a credit score between 601 and 660 should look for an interest rate under 11%.

Consumers with credit scores below 601 tend to pay interest rates that are 17% or more for used cars, astronomically high interest rates that make cars harder to afford, and that make it more likely that a car will ultimately get repossessed. If you’re in that boat and you’re able to make do without a car, it can be a smart move to try to improve your credit score before shopping. Focusing on paying down any credit card debt, making all loan payments on time, and waiting for negative information on your credit report to “age off” your credit report may ultimately save you thousands of dollars on your car.  

A common misconception about getting a car loan at a car dealership, sometimes called a “captive” auto loan, is that there’s no wiggle room to negotiate. In fact, when the finance manager at the car dealership plugs in your information, they typically are sending it out to multiple auto lenders, which might include banks, credit unions, and speciality auto lenders. It might sound unethical, but the car dealer isn’t required to tell you about all the loans you were offered, or even to present you with the best loan that was available!

Many auto lenders let the finance managers at the car dealership tack on extra points onto the interest rate. This “participation rate” can be up to 2.5 extra percentage points that is at the discretion of the car dealer, and that lines the car dealership’s pockets, rather than being sent to the auto lender. If the dealer doesn’t think you’re a savvy shopper, they may show you only the loan with the markup, rather than the cheaper loan another lender offered you.

In 2020, Outside Financial estimated that the average car loan had a markup of $886.

Show Up At The Dealership With Your Own Financing

You don’t have to get your car loan at the auto dealership. Many banks, credit unions, and auto lenders let you arrange a “direct” auto loan, bypassing the finance office of the dealership altogether.

As of July 27, PenFed Credit Union offered auto loan interest rates as low as .99%, and Alliant Federal Credit Union offered auto loan interest rates as 2.24%. Credit unions often offer affordable loans because these organizations are not-for-profit.

You might not find a better deal with a direct auto loan than you’ll get at the car dealership, but it gives you a negotiating tool. But don’t disclose that you’ve found your own financing until after you’ve reached an agreement on the car’s purchase price — if the dealer knows they won’t be able to squeeze you on the loan terms, they’ll be less likely to cut you a deal on the vehicle price itself.

You’ll still want to hear what APR the dealer’s lending partners will offer you, but showing up with your own financing gives you a second option.