By AnnaMaria Andriotis
Car loans may be getting easier to come by, but that doesn’t mean they are always a good deal.
Banks and lenders may still be reluctant to lend to all but the most creditworthy homebuyers, but they’re increasingly doling out money to consumers buying cars, including borrowers with low credit scores, according to a report today in The Wall Street Journal. These looser standards are likely responsible for the 5.7% increase in total outstanding car loans Experian reports for the second-quarter compared to a year ago.
But with many borrowers facing sky high rates, advisers say the loans are far from affordable. Indeed, while car loan interest rates for borrowers with near-perfect credit remain at around 3% on average, buyers with bad credit pay up to 10 percentage points extra, according to Experian. During the first quarter of this year, borrowers who signed up for a new car loan and had credit scores ranging from 620 to 679 received an average rate of 6.5%, while those with scores from 550 to 619 got a 9.9% average rate, and borrowers with scores below 550 signed up for a 12.9% rate on average. (Scores are based on the PLUS score range of 330 to 830.)
For the many borrowers with bad credit — nearly one-half of auto loans were subprime (that’s borrowers with a score below 680) in the first quarter, according to most recent data from Experian — “it’s hard to see how that’s a good proposition,” says Chris Kukla, senior counsel for government affairs at the Center for Responsible Lending. Buyers, after all, pay thousands of dollars extra in interest over the life of their loan. On an average $25,995 car loan, a borrower in the highest credit bracket with a 3.2% rate will pay $2,323 in interest over 64 months of repaying the loan (the average repayment period) while a borrower with a 12.9% rate will pay roughly $10,100 in interest.
Lenders counter that extending car loans to subprime borrowers is the first step to loosening credit overall standards. “It shows a sign of optimism on the part of banks and lenders,” says Robert Strand, senior economist at the American Bankers Association. Car loans present a smaller risk to banks because they’re a smaller dollar amount and are repaid over a faster period than mortgages, and if borrowers fall behind on payments repossessing a car is easier than a home, says Strand. They also present a profit opportunity given the spread between the low rates banks pay out to consumers on deposit accounts compared to the interest they earn from these loans.
Borrowers with high credit scores have several opportunities to save on car loans. Lender rates remain affordable at around 3% on average, according to Experian. In addition, they can qualify for rates of 0% to 1% at dealerships on many car models. For everyone else, here are four strategies to get a better deal on an auto loan.
Get approved for a loan before arriving at the dealership. Consumers with poor credit who need a new car might want to shop around for loans first and the cars second. Banks and credit unions tend to offer lower rates to these borrowers, says Alec Gutierrez, senior market analyst for automotive insights at Kelley Blue Book. When dealerships give out car loans, they often get them from banks and tack on an extra one to two percentage points that they keep as profit, Gutierrez says.
Wait until the fall. Borrowers who decide to go with a dealership may find it pays to wait. In September and October, most 2013 models will arrive at dealerships, and they’ll roll out incentives to unload the remaining 2012 models, which could include lower rates on car loans. Borrowers with low credit scores could end up with a rate that’s one to two percentage points lower than what they’d get now, Gutierrez says.
Make a larger down payment. Just like a mortgage, larger down payments often result in lower interest on car loans. Borrowers who have extra cash on hand should ask how their rate will change if they put more money down than they originally offered, or if they’re planning on selling their existing car, they can trade it in at the dealership and use its value as part of the down payment on the new car, says Thomas King, a senior director who tracks vehicle sales transactions at J.D. Power and Associates.
Bite the bullet…and then refinance. Whatever rate they get, borrowers should keep in mind that it’s not set in stone. If they’re able to improve their credit score, they can refinance into a lower rate. Most banks and credit unions refinance car loans. And unlike refinancing mortgages, borrowers don’t incur hefty fees when refinancing a car loan.