The Reserve Bank of Australia recently raised its cash rate by 50 basis points this June in an effort to curb inflation. Rate hikes like this tend to cause uncertainty and may lead to consumers holding off on making any large purchases or applying for new loans.
This uncertainty extends to car financing as auto buyers can expect to see higher financing costs on both new and used vehicles. Let’s kick any concerns you may have to the curb. In this handy guide, we’ll go over how rising interest rates affect auto loan rates and what you can do as a consumer when dealing with rising interest rates.
Reasons for Rate Hikes
Global banking systems generally increase rates to slow growth and reduce borrowing and inflation. These rate increases get passed to various forms of borrowing like credit cards, mortgages, and auto loans.
Higher rates typically equate to falling demand, but what do you do when you are shopping around for a new or used vehicle? How do these rate hikes affect what you’re hoping to purchase?
If the car you’re currently driving already has a fixed rate, you won’t have to worry too much as your rate was locked in upon signing. For variable rate loans, you can expect your rate to go up.
Most lenders have increased car loan rates across the country, but the rate you receive will be dependent on a few factors.
Factors Affecting Auto Rates
Car loans get structured on an individual basis. Meaning that borrowers receive rates best suited to their personal financial situation. When determining your rate, lenders will take into account factors such as:
- Credit history
- Age of vehicle
In addition to determining the rate, certain factors that will affect your repayment amounts will include the length of the loan term and the overall amount of the vehicle.
When you sign for a variable-rate loan, your monthly payments will invariably change when interest rates change. Whether your rate goes up or down depends on the current market rates. At the time of this article, your rate has likely already risen. Luckily, many of the vehicle loans offered by dealers and lenders tend to come with a fixed rate.
An often-overlooked factor for high car loan rates is the overall supply and demand of vehicles and vehicle parts. It’s no secret the supply chain has felt major upheaval in recent years, making it harder to navigate the waters of vehicle borrowing and ownership.
Manufacturers are dealing with unprecedented supply shortages, leading to an increase in extended delivery times. With production slowed or halted on many vehicles, demand for available supply has shot up.
Increased demand for a smaller supply of vehicles generally causes lenders to hold off on providing discounted rates. A dwindling supply doesn’t typically lead to low rates. When inventory shortages abound, you can expect rising rates to be the norm.
As mentioned previously, the amount you borrow up front will affect the amount you pay throughout the life of the loan. The loan amount itself coupled with the value of your car is referred to as a loan-to-value ratio. LTV for short.
For example, if you have your eye on a $20,000.00 car and you end up financing the entire $20,000.00, your LTV will be 100%.
Those numbers are an overly simplified version, but lenders do use LTV ratios as one of the deciding factors when assessing the overall risk of a loan. The higher the LTV, the less likely you will be to get a good interest rate. No lender wants to provide risky financing.
LTV gives lenders a good picture of how much cushion they have if a borrower defaults on their loan. The higher the LTV, the higher the risk. To balance out this risk, lenders will generally charge a higher interest rate to compensate. You can quickly calculate a car’s LTV as follows:
- Confirm the balance of your loan
- Confirm the value of your car
- Divide the loan balance by the car’s value
- Multiply by 100 to obtain the percentage
Voilà, you’ve got your LTV.
How to Save
Now that we’ve determined interest rate hikes can make it difficult to buy a new or used vehicle, are there steps you can take to insulate yourself from interest rate fluctuations? The good answer is: yes. Here are a few tips and tricks that can help you save if you’re dealing with rising interest rates.
Avoid Residual Payments
Some lenders will offer residual payments as part of your loan terms. This is also referred to as a balloon payment. Balloon payment options are generally structured when you make regular monthly payments, but you pay the final loan amount at the end term of your loan as one lump sum.
Your monthly payments leading up to that point will generally be smaller. However, the lump sum will have to be paid back with interest upon its due date. This means that the total loan cost actually ends up being higher.
If you can afford to, avoid structuring your loan terms without having to pay a balloon payment.
As far as steps to take to save on your car loan when interest rates are rising, doing your research beforehand is a simple one. Before you head to the dealership, comparing rates and loans online can help with securing a better deal down the line. Having a solid idea of what you can afford will help you negotiate more confidently.
By the time you’re ready to receive an offer from a dealer or lender, you’ll know your preferred loan terms. Remember: monthly payments alone should not be your only focus. Instead, try to focus on negotiating interest rates (when you can) and overall loan term lengths.
Be Aware of Additional Costs
Rising interest rates tend to indicate the price of other consumer goods will be rising as well. When you buy a car, you’ll also need to be prepared to pay for items like registration, petrol costs, stamp duty, and car insurance.
Some lenders will cover these costs in tandem with the vehicle cost. However, try to pay for these items up front as adding to the overall cost of your loan will simply cause you to pay more in interest.
Chip Away Those Payments
In a rising interest rate economy, you might not be able to negotiate an interest rate reduction, but you can focus on making regular payments. An even more efficacious tactic would be to make one extra payment per year.
Higher interest rates equate to you paying more money in interest over the life of your loan. In order to chip away at that amount, you can make extra payments. There are a few options for this:
- Pay your monthly payment over two-week increments
- Pay one extra payment once a year
- Round up your monthly payment
Any of these will help decrease the amount you pay in interest throughout the year and throughout the entire overall loan term.
Certain lenders will also offer incentives for you to skip payments if you’ve had good borrowing history. Try to avoid taking advantage of these offers when possible. Skipped payments lengthen your loan term overall, thus adding to the amount in interest you pay.
Make a Down Payment
If you’re able, putting money down when you buy a car is another great way to reduce the amount of interest you’ll end up paying.
Not only will you be paying interest on a smaller loan balance, but putting a down payment on a car will also help reduce your LTV. In turn, this could help you get a better rate with your dealer or lender.
Keep an Eye Out for Deals
While a competitive market might make it difficult to negotiate rates, one thing you can look out for is any sales events or promotional items from dealerships. Some dealerships provide specials on leases or cash-back incentives.
Many dealers hope to get rid of slower-selling models through various incentives like rebates or deals on leasing.
Are You Ready for Rising Interest Rates?
With rising interest rates and an interrupted supply chain, searching for a new or used car might feel like a daunting task. However, if you’re able to sit back and take some time to go over your options, obtaining a car loan isn’t as stressful as you might think.
Knowing your options is a good place to start. At C1 Car Loans, we’re driven by a mission to provide Australians with affordable financing options. Unlike traditional financial institutions, we don’t slam the door on those with an impaired credit history. Contact us today to get started.