When interest rates fall and used-car prices rise, it creates a money-saving "sweet spot" for car buyers. In some cases, owners of 1- to 3-year-old vehicles can trade in their used cars and finance new cars at lower monthly payments with no money out of pocket. Sometimes, the sweet spot can reduce a monthly payment considerably — in our example below, by $93 a month. Meanwhile, the buyer enjoys all the benefits of a new car, such as cutting-edge technology and advanced safety features.
Another factor that can create a sweet spot is when dealers search for vehicles they can buy for their certified pre-owned (CPO) programs. When used car inventories become tight, it drives up used car prices at auctions and trade-in prices for consumers.
"It's hard to believe, but sometimes, for the same money you're paying, you could move up to a new car with lower payments," says Richard Arca, Edmunds' senior manager of pricing. This can be particularly attractive to shoppers when popular cars undergo a redesign, he says.
Here's an example of how to use this car-buying sweet spot. Say you bought a new car three years ago for $20,000 and financed it at the then-current rate of 7.4 percent. Your current payments on a five-year loan would be $400 per month and you would still owe about $7,000.
Let's say you read interest rates have fallen dramatically and you find your car is worth $12,000. You can pay off the current loan and still have $5,000 to use for a down payment on a new car. You then buy the new car for $23,000, put $5,000 down and finance the remaining $18,000 at 0.9 percent. Your monthly payment for the new car would be $307. (Note: Taxes and registry fees are not included in this calculation.)
The beauty of this arrangement is that you could make this transaction without any cash out of pocket. But it is important to understand that with your 3-year-old car, you would be just two years away from paying off the loan. At that point you would have no payment at all, which is a tremendous relief for many people. If you negotiate a "sweet spot" deal, it's important to remember that even though you will have a new car at a lower price, you will have five years of payments.
The Interest Rate: An Ignored Expense
Low interest rates are the real key to sweet-spot deals. Many car buyers don't realize the full cost of interest spread over a five-year loan. "It's important to remember that interest paid on a car loan is lost forever," Arca noted. "It's not like interest on a home mortgage, which is tax-deductible."
Arca summarized the interest costs on a five-year auto loan of a $20,000 car to demonstrate: A five-year loan at 7.4 percent interest costs the buyer $4,000 in interest. A five-year loan at 4.7 percent interest costs the buyer $2,500. A five-year loan at 0.9 percent interest is a mere $460.
The automakers' "captive" finance companies (lenders set up solely to make car loans) periodically slash interest rates. However, keep in mind that incentives are sometimes regional and may not be offered in your area. And only those borrowers with top-tier credit will qualify for zero-percent financing.
How To Tell if You're in the Sweet Spot
If you bought your car within the last three years and think you might be in the sweet spot, use our basic Monthly Loan Payment Calculator to evaluate your situation. Select the car you want to buy and then put in your trade-in vehicle. You will need to know your current interest rate and determine how much you still owe on the loan, but you can find this information on your payment slip.
Now, check incentives to see if low-interest financing is being offered on the car you want to buy. Then plug that interest rate into the calculator under "Market Finance Rate" and click on the "Calculate" button at the bottom. You will see what your monthly payment will be. If it's less than your current monthly payment, you could consider making this vehicle upgrade.
