A unique combination of falling interest rates and rising used-car prices is creating 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 save as much as $93 a month and let the buyer enjoy all the benefits of a new car with cutting-edge technology and better safety features.
Another factor creating this sweet spot is that dealers are searching for vehicles they can buy for their certified pre-owned (CPO) programs. Used-car inventories are tight now, and this is driving up prices at auctions and trade-in prices for consumers.
"It's hard to believe, but for the same money you're paying now, you could have a new car with lower payments," said Ivan Drury, Edmunds.com's supervisor of pricing and industry analysis. "This is particularly attractive since many of the mainstream vehicles have been redesigned in the past year or two."
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 payments on a five-year loan would be $400 per month and you would still owe about $7,000. If you traded in that car, you would get about $12,000 and, after paying off the current loan, you would have $5,000, which you can use for a down payment. You could then buy a new car for the current cost of $23,000, minus the $5,000 down payment and finance $18,000 at 0.9 percent — a not-uncommon interest rate these days. 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 are still facing 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," Drury noted. "It's not like interest on a home mortgage, which is tax-deductible."
Drury 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. 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.
Recently, the automakers' "captive" finance companies — lenders set up solely to make car loans — have been slashing 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 Auto Loan 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.
