After a prolonged recession with years of tight credit, auto financing for new and used car shoppers is plentiful. Credit restrictions have eased and interest rates, while possibly going up, are still near historic lows. Even people with imperfect credit scores can find financing for their car purchases, auto financing experts say.
"It's a very attractive market right now," says Melinda Zabritski, senior director of automotive credit for Experian. However, lenders are still a little more conservative than they were before the recession, which started in 2008, Zabritski says. Despite this, she says the automotive sector of the economy is no longer recovering. It has recovered.
"The economy is the best it has been since before the recession," says Brenda Rios, spokeswoman for Ally Financial, the lender formerly known as GMAC. She notes that there have been 15 consecutive quarters of expanding economic output since the end of 2009, and the majority of forecasting economists expect that the U.S. will continue to grow without recession for the next three years at least.
The subprime end of the lending spectrum is better, too, says Laurie W. Kight, vice president of communications for RoadLoans.com, a brand of Santander Consumer USA Inc.
"Competition is heating up among lenders," Kight says. This means that "credit is readily available for most car shoppers." She noted that leasing has made a strong comeback. In fact, Edmunds.com data shows leasing nearing an all-time high, with 25 percent of all car buyers choosing this form of financing.
These rosy economic assessments mean car buyers have more options when choosing how to buy or lease a new or used car. But easily available credit also brings a warning.
Chris Kukla, senior vice president of the Center for Responsible Lending, sounds a note of caution, saying that easy credit availability means some consumers might buy a car they really can't afford.
Investors are showing a lot of interest in subprime auto financing companies, Kukla says. "We are seeing some concern that a lot of this growth comes from relaxed underwriting standards," which was one of the problems that led the country into the recession in 2008, he adds.
There's no question, though, that interest rates are extremely low, partly because many automakers are subsidizing rates in the form of incentives to spur sales. In September 2011, for instance, a buyer with excellent credit and a 60-month loan from a bank was paying an annual rate of 3.73 percent. This same loan in May 2013 had fallen even more, to 3.22 percent for banks and 2.97 percent for credit unions.
The chart below gathers other national averages for new-car loans for borrowers in several tiers of creditworthiness as of May 2013. These rates are only estimates, and actual rates will vary depending on individual characteristics of the borrower's finances and credit history.
New Auto Loan Rates Tier 1 (720+) Bank Rates Credit Union Rates 36 months 3.20% 2.79% 48 months 3.20% 2.88% 60 months 3.22% 2.97% Typical down payment required 0% 0% Tier 2 (700-719) Bank Rates Credit Union Rates 36 months 3.31% 3.25% 48 months 3.31% 3.34% 60 months 3.34% 3.44% Typical down payment required 0% 0% Tier 3 (670-699) Bank Rates Credit Union Rates 36 months 4.83% 4.09% 48 months 4.83% 4.18% 60 months 4.86% 4.27% Typical down payment required 10% 0% Tier 4 (630-669) Bank Rates Credit Union Rates 36 months 6.43% 5.78% 48 months 6.44% 5.87% 60 months 6.49% 5.99% Typical down payment required 15% 0% Footnotes Bank rates are the average rates of more than 900 lending institutions as of May 14, 2013. Credit union rates are the average of several prominent credit unions as of May 14, 2013. Note: These rates are estimates, and actual rates will vary. In addition, factors such as employment stability, household income, explainable credit troubles (i.e. bankruptcy due to medical bills) and an unusually high down payment can make a significant difference in lenders' loan decisions and the rates they charge. Source: Informa Research Services, Inc., Calabasas, California
The "Primes" Are on Cruise Control
According to Experian data, it's smooth sailing for prime borrowers (those with a credit score of 680-739) or "super prime" borrowers (with a credit score of 740 and higher).
"You have such incredibly low rates out there now," Zabritski says. Furthermore, lenders are willing to make longer-term loans, which is bringing the monthly payment down and making car buying more affordable.
Because of low interest rates, new and used cars are more affordable than in the past five years, she adds. Now, the average payment for a new car is $460 a month on a five-year loan. For used cars, the average monthly payment is $348 for four years.
Super prime and prime borrowers are the people who tend to qualify for the heavily advertised low promotional APR rates. Automakers prefer these incentives to bonus cash rebates. They know not everyone will qualify, and the risk associated with lending to prime customers is much lower.
It's a slightly different story for subprime borrowers, Kight says. Subprime borrowers (those with credit scores of 619 and below) have to come in with at least a 20 percent down payment, she says. "If you want to purchase a car that costs $15,000, you've got to come up with $3,000 in cold hard cash."
Interest Rates Higher With Used Cars
Although Experian's data shows that interest rates are higher with used cars, the average credit score for a used-car customer is significantly lower than that of a new-car customer. In other words, a buyer might have to deal with a higher interest rate, but the price of the car will be lower and there is a greater chance of being approved for the loan.
It's also easier to qualify for a leasing contract today, the experts say. During the recession, many of the domestic automakers cut back on leasing because the residual values of their cars were too low. Now, more automakers are offering leases and are willing to subsidize lease deals with lower monthly payments for customers with good credit.
The Downside of an Up Economy
The Center for Responsible Lending's Kukla reminds consumers to choose loans wisely. This means understanding what interest rate they are paying and what the terms of the loan will mean for them. He recalls that before the recession, some lenders offered eight- and nine-year loans. Such long terms seem attractive but force consumers to pay more interest and run the risk of making them "upside down" in the car loan, owing more on the car than it is worth. Now, loan terms are rising again, re-creating such potentially dangerous situations.
"We have seen reports that say the kinds of practices that led to a crash in the auto market in 2008 are happening again," Kukla says. "The growth in buy-here, pay-here car lots, the growth in the subprime market raises some red flags." This is particularly true when other economic indicators, such as wages, are not rising.
Credit Tips for Car Buyers
To borrow wisely, car shoppers should brush up on borrowing basics before they visit dealerships.
1. Set a budget: A good benchmark is that a monthly car payment shouldn't exceed 18 percent of monthly take-home pay. Within that 18 percent, borrowers should be sure to include the purchase price of the vehicle, fuel and insurance costs. Use this Edmunds car affordability calculator to find the best loan terms and purchase price for you. If a new car is still out of your price range, consider buying a used car instead.
2. Do a yearly credit check: Consumers can check their credit once a year for free at annualcreditreport.com. The report tells borrowers their credit tier and what range of interest rates to expect. If there are any mistakes or other issues, this is the time for a consumer to contest them or settle outstanding debts.
3. Get pre-approved for a loan: Pre-approval lets buyers focus on negotiations without the distraction of arranging a loan. A loan from an independent lender tells the buyer how much to finance and the actual interest rate. If the car dealer then offers a loan with a promotional APR, it will be obvious if it's a good rate or not.
4. Learn the lingo: Borrowers should know the terms they're likely to encounter in the course of purchasing or financing a vehicle. These financing and leasing glossaries can help.
5. Be prepared to make a larger down payment: A 20 percent down payment is a good idea regardless of the buyer's credit tier. For borrowers with good credit, the down payment will help offset the car's first year of depreciation and reduce the chances of your owing more than the car is worth "upside down." Subprime borrowers will likely need to put down at least 20 percent for approval. Smart buyers will have saved for the down payment.
