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What the Fed’s Interest Rate Hike Means for Car Loans

By Aaron Crowe

Title LoanA move by the Federal Reserve late last year to slightly raise interest rates shouldn’t be a reason for potential car buyers to rush out and buy because they’re worried car loan rates will rise.

That’s the good news, lending experts say, especially at a time when car loans are so cheap: Five-year loans cost less than 2.5 percent for a new car and around 2.75 percent for a used car, according to recent figures from Bank of America.

The bad news is that over the next year or so, auto loan rates may rise, and the days of zero percent financing for new car loans could be ending sooner than you’d think.

After 10 years of not moving the federal funds rate — the internal interest rate banks are charged for borrowing money — the nation’s central bank raised it in mid-December from 0.25 percent to 0.5 percent.

The increase is likely to trickle down to loans for homes, small businesses, credit cards and cars.

The recent move may not have much short-term impact, but if the Federal Reserve continues raising interest rates, even slowly, then loan rates could also increase.

“The Fed may have been a little overly optimistic when they bumped up rates,” says Kirk Chewning, owner of Cane Bay Partners, a management consulting company.

The stock market struggled in early 2016, and the Fed may lower rates in the coming months to help improve the economy, Chewning says.

Only $171 more over 5-year loan

In hard numbers, a slight increase in the annual interest rate on a car loan doesn’t affect the cost much.

The vCalc blog gives the example of borrowing $25,000 to buy a new Honda Accord at two interest rates — 4.67 percent and 5.17 percent (which is 0.25 percent on top of the normal rate due to the Fed’s hike). Both loans are for 60 months.

For the 4.67 percent loan, the monthly payment is $468.01. The total cost with interest is $28,080.60, with $3,080.60 of that in finance charges.

After the Fed hiked the rate, a 4.92 percent loan would have a monthly payment of $470.87, or $2.86 more than without the rate hike. The total cost would increase by $171.60 total to $28,352.20.

The vCalc site doesn’t get into used-car loans, which are usually higher than new-car loans and are at rates that move slower.

Buy now?

The potential for future interest rate increases is higher with the Fed’s move, but that shouldn’t be a main concern when considering buying a car, says Robert R. Johnson, president of The American College of Financial Services in Bryn Mawr, Pennsylvania.

“I wouldn’t let interest rates be the decision-driver, but certainly auto loan rates will rise in the future as the Fed raises interest rates,” Johnson says.

Interest rates may go up in the next year or so, making this a good time to take advantage of low loan rates, Chewning says.

“Now is a great time to be buying a car from the standpoint of interest rates,” he says.

Zero percent loans going away?

Some auto dealers are still offering zero percent financing for new cars, giving a free loan for up to five years. Such loans may become less prevalent if interest rates rise, Chewning says, but are smart offers from dealers who want to bring in customers.

“If you can find zero percent financing, that’s a great way to go,” he says.

However, dealers may just increase the new car’s price to make up for not making a profit on a loan, Chewning says.

“A deal may be there, but you need to understand the car price,” he says.

The best place to get a car loan if you can’t find zero percent financing? Your local credit union. Most credit unions have expanded their membership requirements to allow more people to join.

“Credit unions many times provide some of the best rates that are out there,” Chewning says.