How to save on auto loans as the federal funds rate changes
Key takeaways
- The Federal Open Market Committee (FOMC) sets the benchmark rate, which impacts the rates auto lenders set.
- When the federal funds rate fluctuates, so will the cost to finance a vehicle.
- The Fed increased the benchmark rate 11 times between 2022 and 2023, but has just cut rates for the third time in 2024.
- While auto loan rates have begun to decrease, it will likely take several rate cuts before borrowers see significantly lower rates.
Over the last two years, Americans have dealt with steep auto loan rates as the Federal Reserve worked to quell inflation by pumping up the federal funds rate. As of November, these efforts appear to be paying off: The inflation rate is 2.7 percent, just over half a percentage point above the Fed’s goal of 2 percent.
After the Federal Reserve’s December meeting, the federal funds target rate has seen its third cut since 2021. That said, while auto loan rates may decline over time, relief may be slow to arrive.
The Federal Open Market Committee sets the benchmark federal funds rate, which has a domino effect on auto loan rates.
How to save money regardless of the fed rate
The key to saving money is preparedness. So, while the cost to borrow money increases, there are still ways to find your lowest possible rate.
Apply for loan preapproval
By applying for auto loan preapproval, you can lock down your expected monthly cost before signing off on your vehicle. It gives you a firm grasp on the true cost of your new car and gives you a leg up during negotiation. You can also use the preapproved rate when comparing other loan options.
Consider a trade-in
Trading in your current vehicle is a great way to drive off with a new car while spending less cash on a down payment. It will also save you the headaches of selling your car privately.
Shop around
Experts recommend that you compare at least three different loan offers when looking for vehicle financing. Do not sign off on the first deal you come across, and understand that dealer financing often costs more than financing offered by outside lenders.
Focus on affordability
As with all large purchases, it’s essential to calculate your loan cost ahead of time to ensure that you only sign off on a vehicle that you can afford. This way, you can ensure you can keep up with your monthly payments and be prepared for even the worst-case scenario.
Buy hybrid or fully electric
While buying EVs tends to carry a higher purchase price tag, they can be much less expensive over the lifetime of ownership. Check out special tax credits offered in your state as well as green auto loans to save money on an eco-friendly vehicle.
Results of the December Fed meeting
At the December meeting, the Fed announced a third rate cut — a quarter of a percentage point, putting the federal funds target rate at 4.25-4.5 percent.
A lowered federal funds rate is the result of cooling inflation, and the Fed followed economic projections in December by cutting rates again before the start of 2025. Unfortunately, while the federal funds rate is no longer at a 22-year high, there may not be a reduction in the cost of auto loans for the average consumer.
“Throughout history, when inflation rises or even looks like it’s about to take off, the Federal Reserve has been called to action,” explains Sarah Foster, senior U.S. economy reporter at Bankrate.
They do this by “raising interest rates to cool demand and bring prices back into better balance,” she concludes. And this is what the FOMC has been up to — raising rates to try and address high inflation. But most Americans, she explains, see the pain before they see the gain.
Borrowers feel that pain when financing big-ticket items such as new vehicles. Lenders raised rates over the last few years in response to a higher benchmark rate. And these higher rates have, combined with higher prices, made a challenging environment for many.
Even with more rate cuts projected for the near future, it could take months for auto loan rates to see a significant drop.
Current state of the car-buying market
While vehicle prices are leveling out after a two-year period of rate raising by the Fed, average transaction prices are still on the rise. Average transaction prices in November 2024 were up 1.5 percent compared to November 2023, according to Kelley Blue Book.
In early 2023, new vehicle prices peaked at close to $50,000, which, combined with higher rates, made for a steep monthly cost. Higher levels of inventory and growing vehicle incentives pushed previously high prices down. The average new vehicle price in November 2024 was $48,724.
Drivers financing used cars pay an average of $520 each month, and those financing new ones paid $737 each month, according to Experian.
How much are drivers spending?
Drivers financing used cars pay an average of $523 each month, and those financing new ones paid $735 each month, according to third quarter data from Experian.
“If sales volumes in November are any indication, we think 2024 will end on a positive note for the auto business. Yes, prices are trending higher year over year, but higher incentives and discounts are bringing in buyers,” said Erin Keating, Executive Analyst at Cox Automotive, regarding 2024 end-of-year prices.
While year-over-year prices are trending slightly upward, new car prices are leveling out compared to past years and discounts are also increasing.
Bottom line
While it’s true that a steep benchmark rate will impact your available rates, it is not all bad news. The FOMC has stepped in with a lower base rate, vehicle prices have declined and there are still ways to save money when financing your vehicle.
Stay up to date on current Federal Reserve news, understand how future changes can impact your budget and compare available loan rates.
