The new reality: A $700 monthly car payment

(NerdWallet) – When average monthly new-car payments surpassed $700 in May and car prices reached record highs, many potential car buyers decided to sit on the sidelines until the market returned to normal.

Six months later, normal looks further away than ever. The Federal Reserve continues to raise the federal funds rate, driving auto loan interest rates to a 20-year high, and the average new-car transaction price remains above $48,000.

According to data company Cox Automotive, the average monthly new-car payment hit another record high of $748 in October. Average used-car payments have surpassed $550, based on a 70-month-term loan and 10% down.

Automotive research firm Edmunds lists October's average car loan APR as 6.3% for new and 9.6% for used. Ivan Drury, Edmunds senior manager of insights, says slight improvements in car supplies and pricing are being negated by increasing rates.

"Even if you save $500 on a car's purchase price, it could be obliterated on interest rate if you don't get the exact APR that you need," Drury says.

To illustrate Drury's point, financing a $46,000 car for six years with a 3.1% APR would result in a $700 car payment. Reduce the loan amount to $42,000 at 6.3% APR for the same term, and you still have a $700 car payment.

Matt Degen, senior editor with Kelley Blue Book, says, "From what we've seen so far, it's still getting tougher out there to get even a used car. And I don't know that's going to be changing much. Even if the inventory issues recede more, with rising interest rates and tighter lending standards, that could just be another difficulty for folks to overcome."

High car payments are affecting all car-buying segments

During Cox Automotive's quarterly auto industry call, senior economist Charlie Chesbrough said, "No buyer can escape these higher rates. They are being passed along to everyone, and this means that monthly payments will be pushed even higher."

On the same call, chief economist Jonathan Smoke said the "lethal combination" of high car prices and high interest rates is eliminating buyers with lower income and lower credit scores from the car market.

On the other end of the spectrum, Edmunds recently reported 14.3% of consumers are committing to monthly car payments of $1,000 or more when financing a new vehicle. The report pointed to consumer preferences for luxury brands and large trucks and SUVs as one factor behind these $1,000-plus car payments.

Says Drury, "I tell people if a $1,000 car payment makes sense for you mathematically and for your budget, that's fine. But we see in our data where someone may be paying $1,400 a month for a 72-month term at 10% APR. We're talking about nearly $30,000 in finance fees. That I cannot advocate."

When waiting to buy a car isn't an option

Twenty-six-year-old Tim Roeder of Westfield, Indiana, and his wife had no car payments when Roeder's 10-year-old car needed costly repairs. Roeder says they weren't "super excited" to take on a car payment in the current market, but some planning and a job promotion helped them do so.

Roeder and his wife discussed budget, used an auto loan calculator to set a maximum payment amount and researched trade-in values. Roeder took a day off from work and went to the dealership with hard numbers in mind but ready to walk away. He says, "It helped me feel comfortable with the decision and pulling the trigger, because I already knew beforehand what numbers I was OK with."

As Roeder found, running the numbers ahead of time puts guardrails around the purchase, giving buyers the power to say yes or no.

Even as interest rates and car payments rise, conventional car-buying advice can still be helpful for those who can't put off buying a car.

In a typical car market, the rule of thumb is to spend less than 10% of your take-home pay on a car payment. If that's a stretch, try reallocating other spending. Avoid going with a long-term loan to reduce the payment, as you could become upside-down, owing more than the car is worth.

Compare interest rates from different lenders. Many lenders offer pre-qualification, which gives you rate estimates without affecting your credit score. Then, apply for a preapproved loan and bring it to the dealership, giving them a rate to beat. If you don't do your homework and end up with a dealer's double-digit interest rate, you might still be able to refinance to a lower rate and payment with a different lender.

Other long-standing advice is to make a down payment of at least 20% on a new car and 10% for used cars. If this isn't attainable, any amount down can help reduce your payment.

If you can't find a car with a payment that fits your budget, an option may be purchasing a cheaper, higher-mileage used car that's been well-maintained.

Says Drury, "You can get an older vehicle, and thankfully some are good for easily 100,000 miles. I tell people you can buy older and deeper into the used market if you're trying to save some money or just get a vehicle to hold you over for another year or two."

If buying an older vehicle, research models known for longevity, check maintenance records, invest in a prepurchase inspection, and avoid a long-term loan that could leave you upside-down as the car loses value.