Impact of Inflation on Auto Loan Rates

Q: Are interest rates on auto loans rising?

Auto loan interest rates have been on the rise. In the third quarter of 2022, prime rates for auto loans were up 1.22% year-over-year to 4.90% on average, according to Experian’s State of the Automotive Finance Market Q3 2022 report.

Q: What auto loan rate is too high?

Auto loan rates vary from borrower to borrower. What’s too high for one may not be high for another. But consider this: The average deep subprime rate was 12.93% for a loan for a new vehicle. If you have poor credit and you’re being offered rates higher than that, you may want to look into ways to strengthen your credit before buying a car.

Q: Why are auto loan rates so high?

Auto loan interest rates are high now, in part, because the Federal Reserve has been raising the federal funds rate in an effort to control inflation. The federal funds rate, in turn, affects the interest rates lenders charge on loans.

Austin KilhamUpdated April 6, 2023

Share this article:

Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

As inflation rises, your bank account takes a hit in different ways. For instance, high inflation often triggers a rise in interest rates, which makes it more expensive to borrow money, including taking out an auto loan. If you’re looking for a car loan, and you’re wondering, are auto loan rates going up? here’s what you need to know — plus tips that might help you qualify for a lower rate.

What Is the Federal Funds Interest Rate?

One of the main tools the government has for combating inflation is to raise interest rates. They do this via the federal funds rate, which is the rate at which banks borrow money and lend their extra reserves to each other overnight. Banks are required to keep a certain amount of money in reserve to help ensure stability and solvency. If a bank has an excess of reserves, it can lend it to another bank that might not have enough.Banks often use the federal funds rate to set their prime rate, which is the interest rate they charge their most creditworthy customers. They then use that rate as a benchmark to set rates for other lending products.

How Does the Fed Interest Rate Impact Auto Loans?

The higher the federal funds rate is, the more expensive it is for banks to borrow money. Banks, in turn, pass on these higher costs to customers by increasing their prime rate and the amount they charge for consumer loans, such as auto loans.

Why Does Inflation Impact Auto Loans?

Inflation can have a significant impact on auto loan interest rates when the Federal Reserve raises the federal funds rate to try to tame inflation. This has a ripple effect. Banks raise their prime rate as well as the rate they charge on consumer loans. That’s how car loan interest works.Inflation can also affect auto loans by making cars more expensive to purchase. Over the past few years, supply chain issues have reduced the number of cars on the market. At the same time, there’s been increased demand for vehicles, driving the prices up. The more expensive the car, the bigger the loan a borrower might need to take out, and the more interest they’ll pay over the life of the loan. Recommended: 7 Ways to Save Money During Times of High Inflation

Are Auto Loan Rates Going Up?

Auto loan interest rates have been rising recently. In the third quarter of 2022, prime rates for auto loans were 4.90% on average, according to Experian’s State of the Automotive Finance Market Q3 2022 report. That’s an increase of 1.22% year-over-year. Even rates on loans for borrowers with the strongest credit have gone up 1.27%. Meanwhile, subprime loan rates rose to 10.11%. So are car loan interest rates going up? Currently, they are.Recommended: 9 Tips on How to Shop for Auto Loans

Factors that Impact Auto Loan Rates

Why are car loan interest rates so high? A lender’s prime rate serves as a benchmark to help them determine what interest rate to offer you on a car loan. But that’s not the only factor in the equation. These are some of the other things that can affect the auto loan rate you get:

Creditworthiness

Your credit history is one of the biggest measures lenders use to decide your auto loan interest rate. Specifically, they look at your credit score. A higher credit score indicates that you have a history of managing your debt responsibly and paying your bills on time. Borrowers with higher scores usually have an easier time qualifying for loan and securing the lowest interest rates. Those with lower scores are considered riskier, and more likely to default on a loan. Lenders generally offset this risk by charging more interest.

Debt-to-income Ratio

Your debt-to-income ratio (DTI) is how much monthly debt you have compared to your gross monthly income. The lower your DTI, the better. Ideally, lenders prefer a DTI of 36% or less for auto loans. The higher your DTI, the more a lender may worry that you’re stretching yourself financially, making it harder for you to keep up with payments on a new loan. To offset this risk, they may offer you a loan with a higher interest rate.

Amount Borrowed and Down Payment

The more money you borrow to buy a car, the higher your interest rate is likely to be. That’s because the lender is taking on more risk. Conversely, the bigger your down payment, the less risk for the lender, which translates to a lower interest rate for you. You can calculate APR on a car loan to determine exactly how much a loan is costing you.

Loan Term

The term or length of a car loan is the number of months or years you have to pay it off. The longer the term, the higher your interest rate. Shortening the term can decrease the interest rate, but it will also increase the amount of your monthly payment.

Ways to Combat High Auto Loan Rates

You might increase your chances of qualifying for a good auto loan interest rate by strengthening your credit score. You may help do this by:

paying your bills on time and in full every month
avoiding taking on new debt
paying off your current debt

As a bonus, these strategies could also help lower your DTI, which may help you qualify for a lower interest rate.Finally, make a bigger down payment on the car, if you can, which could help you qualify for a more favorable rate. Recommended: Is Car Loan Interest Tax Deductible?

Refinance Auto Loans

Refinancing is another method for lowering car payments. When you refinance, you pay off your old loan with a new loan that ideally has a lower interest rate or more manageable terms. If your credit score improves, for instance, that could be a good time to refinance your auto loan, since you may qualify for a better rate.

Auto Loan Refinancing With Lantern

If you’re considering car loan refinancing to get a lower interest rate, be sure to shop around with different lenders. Lantern can help. In our marketplace, you’ll get offers from a number of top lenders all at once so that you can easily compare them and find the best option for you.

Frequently Asked Questions

Are interest rates on auto loans rising?

What auto loan rate is too high?

Why are auto loan rates so high?

Photo credit: iStock/Jinda Noipho

LCAU0123002

About the Author

Austin Kilham

Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.

Share this article: