Home / Auto Refinance Topics / Lower your rate now. The car loan market is inefficient.

  • Nicholas Hinrichsen

Lower your rate now. The car loan market is inefficient.

Updated: Aug 27

Borrowing money to purchase a vehicle is a two-edged sword: on the one hand, a vehicle will allow you to drive to work, be productive and earn a salary. On the other hand, a car is a depreciating asset and if you don't pay off your loan fast enough, you risk owing more than the car is worth.


We therefore asked ourselves, can we rely on the capital market to give car shoppers the best rates?


In an efficient capital market, you would assume a strong, inverse correlation between your credit score and your auto loan rate. As we will demonstrate, however, auto loan rates are all over the map and Americans are overpaying.

Table of contents

  1. How much Americans owe

  2. Financial products are abstract

  3. How come 50% of Americans overpay on their auto loans?

  4. How to refinance your auto loan and save thousands of dollars

How much Americans owe

Americans are regularly criticized for their level of indebtedness. Yet, the stock market is booming and the U.S. is the home of the most valuable companies in the world. So, is debt good or bad?

10% of the borrowers in the world use debt to get richer, 90% use debt to get poorer -- Robert Kiyosaki

As Robert Kiyosaki put it, if you spend the money wisely, your investments will lead to prosperity. For example, you might owe a lot on student loans but your education will be very beneficial to your future and opens up endless possibilities. Equally, you may have to borrow money to purchase a car, yet your car gets you to work, provides job security and the possibility to earn a salary.

Americans currently owe:

  • $1.453 Trillion in student loans

  • $1.267 Trillion in auto loans

  • $868 Billion in credit card debt

These are big numbers and auto loans are one of the biggest debt category. We therefore asked ourselves, can we rely on the capital market to give car shoppers the best rates?


Financial products are abstract


To get a better idea of the market, we recently undertook an in-depth study of outstanding and open auto loans. Our results showed that the market is quite inefficient and many borrowers are not paying the best rate on their auto loan. In fact, our research showed that the rates are all over the map and certainly not as low as they should and could be:

If we were living in an efficient market, consumers would be paying the lowest interest rates possible controlled for their creditworthiness. A borrower with a low credit score should pay a relatively high rate. A borrower with a high credit score should pay a relatively low rate.


Now take a look at the above chart: the turquoise dots reflect 5,000 randomly selected, outstanding and open auto loans with a term of 72 months.


If the auto loan market was efficient, all the turquoise dots would be sitting on the pink line. If the turquoise dots were on the pink line, we would see a strong, inverse correlation between your credit score and your auto loan rate. That's what you would expect, right?

Instead, as you can see from the graph, the studied auto loan rates don't seem to strongly correlate with an increasing credit score. Nearly 50% of the dots are above the pink line; meaning, ~2,500 of the studied 5,000 consumers are overpaying on their auto loan. Our findings are especially stark for Americans with credit scores below 700.


We estimate that consumers are overpaying on the order of $37 billion in interest on their auto loans every single year. In similar studies, CreditKarma and NerdWallet came to the same conclusions.

How come 50% of Americans overpay on their auto loans?


Americans overpay on their auto loans for a number of reasons. We identified two reasons that drive most of the inefficiency:

  1. The Dealer Markup

  2. Credit Migration


The Dealer Markup


79% of all buyers get their loan at the dealership, ... right after they fell in love with the car they test-drove. In fact, I'm willing to bet that if you have a loan, you got it at the dealership, too! People simply don't shop for loans. They shop for cars!


When you get your loan at the dealership, the dealer charges you a significantly higher rate than you could have obtained if you had shopped for a loan yourself:

In our recent article 'How much car dealers make, how to get thousands back', we described that dealers don't generate most of their profit through selling cars. Instead, dealers make most of their money on financing and protection plans.


To say it bluntly: dealers sell cars in order to create an opportunity to sell the much higher margin products, such as financing and protection plans. How is that possible, you might be asking yourself?


When the dealer submits your credit application, he is able and willing to mark up your interest rate to maximize his profit. Car shoppers usually are unaware of the loan terms they could qualify for, which is particularly true for consumers with credit scores below 700.


If the dealer for example tells you 'Great news! Your loan has been approved. You got a great rate at 16%!' you don't realize that the dealer likely added 2% or more to the rate the bank had originally approved. In other words, if the dealer tells you 16%, your rate might have originally been 14% or less.


The 2% markup goes almost entirely into the dealer's pocket and the car shopper ends up in a loan with an excessive interest rate and monthly payment.


Credit Migration


In a recent article, we described that making your car payments is the best way to lower your rate. Despite the Dealer Markup described above, we do in fact see a relatively strong inverse correlation between credit scores and auto loan rates when limiting our sample to loans at the time they were originated:

The chart above uses dummy data to demonstrate how rates tend to go down with increasing credit scores the day the loans were originated. So how are these findings consistent with the chart above?


Over the course of time, car owners make their payments. Not all of them though. On a portfolio of borrowers with challenged credit for example, we're seeing default rates as high as 50%. In other words, some of the car shoppers on the chart above will make their payments and others won't.


When making their payments on time and in full, car owners successfully improve their credit. If we look at an updated chart - again, this is dummy data to help us make our point - we are seeing a subset of the borrowers move horizontally to the right:

As the chart suggests, borrowers who have made their payments and who improved their credit scores are now paying too high rates relative to the car owners who already had a higher credit score when they took out the loan.


We call this phenomenon credit migration, which ultimately explains why auto loan rates end up all over the map.

Refinance your auto loan and save thousands of dollars


When we performed our study above, we felt frustrated for those borrowers who had marked up rates, improved their credit and are still stuck in their original high-interest loans. Clearly, a lot of hard-working Americans are overpaying and hence have higher monthly payments than necessary.


Thankfully, we can help: in our article 'The best way to lower your rate? Make your payments!' we found that a lot of Americans can refinance their car loans and save thousands of dollars.


By making your payments on time, you can significantly improve your credit score in as little as six months. All you need to do is refinance once you qualify for a better rate.


We also found that a lot of Americans are already refinancing their mortgages: 'Refinanced a mortgage? Now refinance your car loan, too!' If you have refinanced your mortgage, we encourage you to also look into refinancing your auto loan now.

WithClutch.com is a fully digital platform that lets car owners like you do so from the comfort of their own home. No need to set a foot in a bank or credit union. You can lower your rate or get cash in as little as 20 seconds.


Follow three simple steps to refinance your auto loan, get approved in seconds and save thousands in minutes.

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