Getting a good interest rate on a car loan means understanding the difference between APR and your rate
The annual percentage rate (APR) on a car loan is one of the best kept secrets of every dealer. Not because they don’t tell you what it is on your loan, but because most people don’t really know what it means.
That makes getting a good APR on your car loan pretty much impossible.
In this article, I’ll not only reveal how to get a low APR on a car loan but how to negotiate to save thousands off your next car purchase.
Why Does the APR Matter on a Car Loan?
Does the APR matter on a car loan? Are you kidding? OK, I’ll admit I just pulled the question from Google as one of the most commonly asked when people buy a car.
I’m not saying you were asking the question…because, really?
The annual percentage rate on a car loan is the total cost of the loan, so yeah it matters a lot. I’ll show you the rates on used and new cars next but an $18,000 loan at 4% APR will cost you $1,890 over a five-year loan. That’s the best rate for a used car on good credit.
Now compare that to the same used car but for a bad credit borrower at a 19% interest rate…and an interest cost of more than $10,000 over the five-year loan.
But there is an important question here. It’s not whether the APR matters on a car loan but the difference between the APR and your interest rate.
You see, the interest rate is what the car dealer shows you when you apply for a loan. The APR is what they murmur under their breath and try to hide with their thumb while holding the loan docs.
That APR is the REAL cost of the loan with all the dealer’s fees included on top of the interest rate. If your dealer is on the level, the APR shouldn’t be more than half a percent above the interest rate. If they’re trying to sneak in all kinds of fees and charges under your nose, the APR is going to be much higher than the interest rate and you’re going to pay thousands more for that car.
Be warned and if you see an APR more than a percent above the stated interest rate…walk away!
Interest Rates on New Car Loans
Interest rates on new car loans are almost always lower than rates on used car loans and this is one of the biggest tricks by dealers. Car dealers make most of their money on the loans they approve to buyers. In fact, the sticker price might only be a hundred or two above what the dealer paid to the manufacturer.
But that five-year loan can mean thousands in interest above the rate dealers pay to borrow money. New car dealers are willing to charge lower rates because they get that extra few percent on a $30,000 new truck rather than an $8,000 jalopy.
A good interest rate on a new car loan is going to depend on your credit score and a few other factors that we’ll talk about later in the article. I’ll show you how these three factors affect your interest rate and how to get a lower rate.
APRs on new cars range from about 3.3% to just over 14% as of 2019. That’s competitive with mortgage rates at the lower end but pushing close to those personal loan rates for bad credit borrowers.
Interest Rates on Used Car Loans
Interest rates on used car loans are higher but still not too bad for good credit borrowers. Part of this is because car loans are secured, meaning the lender can repossess your car if you stop paying. That gives the lender an out and gives you a lower rate.
Another factor keeping used car loan rates low is the fact that the loan amount is usually pretty low compared to other loans. The average American borrows $7,000 for their used car versus tens of thousands for a new car.
Try to get a loan with bad credit though and you’re looking at much higher rates. In fact, if you get a quote for an interest rate above 13%, you might consider getting a personal loan to buy the car instead. With a personal loan, you’ll get a competitive interest rate and don’t have to worry about losing your car if you can’t make the payments.
Can You Negotiate APR on a Car Loan?
You can negotiate anything!!!
The dealer is going to say the interest rate is set by the bank. They’ll say the fees are standard and not up to them (or they would change them if they could). They’re saying that because it’s the biggest chunk of the profits for the dealership and sales staff but you better believe they can change those rates.
Negotiating the APR on a car loan is a lot like negotiating the price. It helps to shop around first to see what kind of offers and rates you get without trying to negotiate. Don’t sign anything! Spend just a little time to do a little planning and you’ll save thousands of dollars in the loan and the price.
Once you know what kind of prices and interest rates you’re being offered, you can start negotiating to save money. Your success here means taking it in this order and using an everything-and-the-kitchen-sink approach to negotiating.
- Make a note of everything the dealer is willing to throw in with the car price. This usually includes extra months’ of warranty or other features. When you start to negotiate on the price, this will become your ammunition. Ask them to lower the price if you drop the extra warranty or features (the warranty and service club is usually a rip-off when offered with the car).
- If they won’t budge on the price, then ask the dealer to lower the interest rate by half a percent. They might say it’s impossible but they ARE able to lower the rate. Even if they absolutely refuse to negotiate on the rate, then they have to negotiate on the price.
- Don’t talk about your trade-in until you have everything else in writing. If they ask, say you’re planning on passing your car down to kids or keeping it. After you’ve negotiated the rock-bottom price and interest rate, then ask how much off you can get with your trade-in.
How to Get a Better Rate on a Car Loan
The APR on a car loan comes down to a few factors, some of which you can directly control.
The APR is the interest rate plus any fees charged by the dealer. Make sure you see the difference between the APR and the interest rate and what fees it represents. You might be able to negotiate some of these fees lower or at least get a discount.
The biggest factor that determines the interest rate on your loan is your credit score and what’s on your credit report. This isn’t something you can change quickly so try planning at least three months ahead of buying a car to increase your FICO score.
Two factors that influence your interest rate that most people don’t realize is the size of your loan and the term limit. Understand that the interest rate is the compensation to the lender for the risk in the loan. Higher risk that the loan won’t be paid means higher rates.
Higher loan amounts mean higher rates because there’s a bigger risk the borrower won’t be able to make the payments. Loans for longer terms like 72- and 80-months are more likely to eventually go into default so these come with higher rates as well.
Put this all together and you start to see a picture for getting the best rate possible. Borrow the least amount possible on the shortest repayment terms. Try increasing your credit score a little and make sure to negotiate out the high dealer fees.
Knowing this, one trick that’s worked for me is getting a personal loan for about half the amount I needed for a used car I wanted. That meant I could borrow the rest through dealer financing on three-year terms for a super-low rate.
Getting a good APR on a car loan means understanding the difference between the APR and interest rate as well as what affects the interest rate. Learn how to negotiate a better interest rate and price for your car and save thousands of dollars.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.