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How does the Fed interest rate affect car loans?

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The Federal Reserve constitutes a multifaceted element within the American economic framework. During approximately eight annual meetings, the Fed determines the cost of borrowing money. Among its responsibilities is establishing a benchmark interest rate for short-term consumer lending, which private lenders reference to set their rates. Should the Fed decide to increase the federal funds rate at a meeting, as was the case in the July session, it’s anticipated that the cost for personal or auto loans will also rise.

How Fed rates affect auto loans

Auto loan rates fluctuate based on various factors such as the time of year, the vehicle type, and the borrower’s credit score, among other considerations. However, auto loan lenders use the benchmark rate set by the Fed as a reference for establishing their rates.

The discussions held by the Federal Open Market Committee (FOMC) during Fed meetings do not directly determine the precise interest rates offered to consumers; instead, they influence the interbank lending costs. Consequently, banks and lenders might modify the rates provided to consumers following changes in the federal funds rate.

If the Fed increases interest rates, it may result in a potential rise in auto loan rates, and conversely, a decrease in the federal funds rate could lead to lowered auto loan rates.

September 2023 Fed meeting

Amid the economic upheavals triggered by the pandemic, the central bank employs rate hikes as a measure to manage inflation. In the recent September Fed meeting, the Federal Open Market Committee (FOMC) chose not to elevate the target range for the federal funds rate, maintaining it between 5.25 and 5.5 percent. This rate stands at its highest level in 22 years post the 0.25 percentage point increase during the July meeting, and the FOMC hinted at a potential final hike in 2023.

While this specific number doesn’t directly dictate auto rates, it’s interconnected with the prime rate. Essentially, the series of 11 rate increases since the start of 2022 could potentially escalate the costs of vehicle financing. However, lenders retain the authority to determine the rates charged to borrowers based on their individual credit history.

Sarah Foster, a senior reporter covering the U.S. economy, highlights the current period as an expensive time to purchase a vehicle, irrespective of rate hikes.

“Car shoppers in the U.S. have faced considerable challenges,” explains Foster. Despite a modest decline, vehicle prices averaged $47,899 in September, as per Kelley Blue Book. However, the persistent high prices are just one aspect of the issue.

“The considerable surge in prices is a classic case of inflation,” notes Foster, “and the subsequent outcome — escalating interest rates — is also in line with this trend.”

Drivers are grappling with the impact of elevated costs for both new and used cars, with average interest rates standing at 6.63 percent for new vehicles and 11.38 percent for used cars, as reported by Experian. The amalgamation of high rates alongside pricier vehicles has created a challenging environment for prospective buyers to navigate.”

Why Fed meetings are important

Federal Reserve meetings hold significance as they provide transparent insights into the economy, particularly regarding anticipated changes and shifts in interest rates. When the Fed declares an increase in interest rates, one can anticipate encountering pricier loans or witnessing an elevation in interest rates for any existing variable-rate loans.

Explore the Federal Reserve hub to understand how the Federal Open Market Committee (FOMC) decisions might influence your financial situation.

How to prepare for future Fed rate changes

Preparation is the cornerstone of saving money. To best equip yourself, it’s vital to familiarize yourself with the current federal funds rate and understand how fluctuations in rates might impact your finances. While the federal funds rate and auto loan rates are distinct, a ripple effect extends to lenders, subsequently influencing the rates you might encounter.

Even though the current federal funds rate sets the general spectrum of available auto loan rates, your credit score plays a pivotal role in determining the actual amount you’ll pay. To secure a loan with the most advantageous terms, maintaining a prime credit score—typically 660 and above—and a strong credit history is crucial. While you can’t control the federal funds rate, you have the power to enhance your credit score, positioning yourself for future vehicle financing.

Next steps

When the Fed makes rate adjustments, potential alterations in available auto loan rates may follow suit. While the Fed’s choices influence your auto loan, the rate you’ll secure is chiefly governed by your financial background and history.

Irrespective of fluctuations in the federal funds rate, proactively position yourself for the most favorable auto loan rate by striving to enhance your credit score and overall financial status. Staying informed about current loan rates before pursuing a new auto loan is also a beneficial practice.

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