How Rising Interest Rates are Affecting Car Sales

The automotive industry is a key part of the US economy and as the Federal Reserve is raising interest rates, it will heavily influence both the demand for cars and the loans that accompany them. Additionally, in today’s economy, car prices are at a record high, causing consumers to take out larger loans for longer periods of time in order to purchase a vehicle.

This year, Bankrate expects average interest rates to rise to 4.5% for new cars and 5.2% for used cars. And according to Quartz, the average subprime auto loan carries a 10% annual interest rate, and some lenders have even pushed rates above 20%, according to New York Times.

With these rising interest rates increasing car buyers’ monthly payments on loans, auto debt and delinquencies are at historically high levels, and rising! This reality is leaving more car consumers “upside down” and forcing car dealerships and F&I managers to face new sales and financing challenges.

Rising Interest Rates Are Leaving More Car Buyers Upside Down

Last year, Americans bought more new cars than ever, but with auto loans also rising, US car consumers were burdened with around $1.2 trillion in outstanding auto loan debt. Likewise, more than six million American consumers are at least 90 days late on their auto loan payments.

It appears that lenders are letting car buyers borrow more than they can afford and a report from Morgan Stanley predicts that the value of used cars will decrease by 25-50% over the next four to five years. These increasingly hefty loans and decreasing vehicle values are contributing to more consumers experiencing negative equity. In a negative equity situation, car buyers will often opt to trade-in their vehicle and roll their auto loan balance into a new loan, essentially financing that negative equity. This only adds to their monthly payments, and can limit the loan options available to the consumer. Further, the rising interest rates and high number of equity trade-ins will restrict the availability of credit to used-car buyers.

So what can car dealerships and F&I managers do to keep up with car sales and help protect their car buyers from ending up “upside down”?

What Dealerships & F&I Mangers Can Do to Support Car Buyers

Because rising interest rates are pushing cars buyers to opt to lease or trade in when in the market for a new car—and putting more consumers into negative equity—the focus of dealerships and F&I managers will shift. It’s important that they support car buyers by educating them on all that factors to consider when trading in and financing, and by providing them with consultative advice.

Dealers should help consumers understand the value of the car they are trading in and how things like mismatched tires or minor dents can decrease the value. To avoid skepticism of the value given to an owner’s current vehicle, dealerships can empower consumers to self-evaluate their trade-in using an online tool.

When it comes to loans, F&I managers can encourage consumers to keep their loan term shorter in order to lower their rate and total interest, which will decrease their risk of being “upside down.” They should also advise buyers to stick to the “20/4/10” rule which states that a buyer should put down at least 20%, keep their loan under four years and ensure that the combined principal, interest and insurance is less than 10% of their household income. They can also recommend gap insurance coverage that can pay the difference between the balance of a lease or loan due on a vehicle and what a consumers insurance company pays, in the event the car is considered a covered total loss.

Lastly, to help consumers avoid unexpected vehicle repairs they can’t afford and to increase trade-in value on their vehicle, dealerships and F&I managers should always encourage buyers to get a vehicle service contract (VSC). A VSC will help protect their investment and increase the value of their vehicle during trade-in, which can help reduce negative equity. Additionally, there are low-interest or zero-interest financing options for VSCs, like an installment payment plan from Budco Financial.

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