What Federal Interest Rate Cuts Could Mean for Car Shoppers

Editor’s note: This story was updated Sept. 19, 2024, to reflect the Federal Reserve’s rate cut announcement.

Wednesday brought some promising news to consumers who have held off on major purchases like vehicles until they can get a better interest rate. The Federal Reserve cut federal interest rates at its September policy meeting, and many economists surveyed by Reuters expect the Fed to cut interest rates twice more before the end of 2024. However, you may not want to go out and buy a new car immediately, as it can take a while — and multiple rate cuts — for it to translate into a significant change for car shoppers.

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The key federal funds rate has been higher than normal for a while, sticking in the 5.25%-5.50% range since July 2023, which Bankrate notes is the highest it’s been since 2001. Though a majority of economists surveyed by Reuters expected a rate cut of 0.25% at the Fed’s September policy meeting, the agency instead announced a 0.5% rate cut. Most economists are predicting two more rate cuts of 0.25% at its meetings in November and December.

Of course, most car shoppers aren’t paying the Fed’s interest rate on their vehicles; the average interest rate for a new-car loan in the second quarter of 2024 was 6.84%, per Experian. A drop in the federal interest rate indirectly affects what consumers pay, so here’s what you should expect if rates go down as predicted.

The Federal Reserve and You

Before we get into auto loans specifically, it helps to understand how the Fed’s interest rates work. The Federal Open Market Committee within the Federal Reserve sets its key federal funds rate, which is what people typically refer to when they talk about federal interest rates. The federal funds rate is a benchmark used for other lenders — specifically, the interest rate that banks use when they lend to each other. When these inter-bank lending rates are high, they typically get passed along to the consumer. If you’ve seen higher auto, home or student loan rates lately, that’s why.

Interest rates are one tool that the Fed uses to regulate inflation. Lower rates tend to boost hiring and consumer spending, as lower-interest loans make funding easier to access. However, that can have the adverse effect of inflation, which is a general increase in the price of goods and services. Higher interest rates can slow down inflation, but they can also slow down hiring and consumers’ willingness to make big purchases — like cars. It’s a balancing act.

The Fed typically aims to keep inflation around 2%, and nearing that goal, combined with a report showing a slightly lower increase in employment than expected in August, signaled to many economists that it’s time to start cutting interest rates.

Curb Your Enthusiasm on Cheaper Auto Loans — for Now

Let’s get back to that 0.5% drop and why you may not want to go on a car-buying spree just yet. A single drop is a good sign that more may be on the way, but it won’t make an immediate dent.

“The impact of a single interest rate drop by the Federal Reserve, whether it’s a quarter-point or a larger half-point is pretty immaterial for car buyers,” said Greg McBride, chief financial analyst at Bankrate, in a call with Cars.com. “The difference of a quarter percentage point on a $35,000 five-year loan is $4 a month.”

“It is going to take a series of rate cuts over the coming year to cumulatively move rates in a significant way that can impact car-buyer affordability,” McBride continued.

If the Fed keeps gnawing away at interest rates after the cuts, it could add up. However, don’t expect major relief for a while.

“Interest rates took the elevator going up, but they’re going to take the stairs coming down — they’re going to come down slowly,” McBride explained.

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What Car Buyers Can Do Now

There are still things you can do to score a better rate in the interim. Numerous items besides the federal interest rate factor into an auto loan’s interest rate, including the borrower’s credit score, the type of vehicle and even the time of year.

“Interest rates are one variable, but they are probably the smallest variable at a time when vehicle prices are high and buyers are financing large amounts and often have little or nothing in the way of equity to roll into the deal,” McBride explained.

While some car buyers may not have the luxury of waiting for a better rate or saving up for a bigger down payment, it’s always a good idea to work toward your overall financial health.

“What does move the needle is improving your credit to make sure you qualify for the best possible rate and shopping around to compare terms and get the best deal,” McBride said. “You have to prioritize debt repayment. Interest rates aren’t going to solve all of your problems.”

If you can make a larger down payment or you have an in-demand car to trade in, simply financing less is probably the best way to score a more manageable monthly payment.

“The fact is, what’s really driving those back-breaking car payments is the sticker price and the amount of it being financed,” McBride said. “Higher rates have played a role, but when you’re financing $35,000 or $40,000 or more, that’s a hefty payment even when rates are low.”

Likewise, aiming for a shorter financing term — such as five years as opposed to seven or eight — can help get a better interest rate. Don’t stretch yourself to the limits to afford a more expensive car.

The good thing is, new-car prices are starting to come down, little by little, as production catches up after the pandemic-era inventory shortages. Much of that growth has been in affordable cars, often under $30,000. Furthermore, with dealerships wanting to shed 2024 models to make room for 2025 ones, this is also the best time of the year to score a deal.

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