As the labor market strengthens and economy activity rises, the Federal Reserve has raised the Federal Funds Rate a quarter percentage point in order to continue to sustain conditions where businesses and individuals can thrive.
Currently, short-term rates are between 1.75% and 2%—up a full percentage from 2017—affecting all market sectors including the automotive industry. This marks the seventh increase since 2015 and the Federal Reserve anticipates two more increases this year.
These interest rate hikes have impacted all players in the automotive industry—manufacturers, dealers, lenders, and consumers—in many ways. Below we’ll take a look at the implication of these increases and the positive and negative consequences.
The Impact on the Auto Market
First off, these increases reflect that the economy is in a growth state, with unemployment and inflation remaining low. The Federal Reserve is simply seeking to return interest rates to a more normal level. Additionally, in 2017, auto sales reached $17.2 million—a milestone that has only been hit once before in 2000-01. In 00-01, the current average loan rate was 6-7%, which is considerably higher than today’s average auto loan rate of 4%. However, within the first quarter of 2018, the average finance amount and monthly payment for new vehicles reached record highs and subprime lending reached a record low.
The Impact on Auto Sales
Looking at automotive sales, the average interest rate for new-vehicle financing raised 31 basis points and used-vehicle financing jumped 29 basis points in the first quarter, compared to last year. It’s more expensive for car buyers to take on new car loans or leases, which is leading to a shift toward used-vehicles being purchased over new and luxury models. With increased interest and higher monthly payments, consumers may also choose to forego expensive accessory or F& I products in lieu of giving up popular option packages that include features like heated seats, satellite radio, or adaptive cruise control. Likewise, in some cases, they may move down a vehicle size to reduce their monthly payment.
The Impact on Auto Financing
When it comes to automotive financing, higher rates and tighter credit will spark more lending caps. The cost of providing low-interest rate loans will increase for OEM incentive spending, and the cost of acquiring and maintaining inventory will increase for dealerships—posing profit margin challenges for both parties. Yet, consumers are offsetting higher rates and sales prices by taking out longer loans and paying more interest over the life of the loan. Subsequently, for lenders, borrowing costs will go up, forcing them to increase fees to dealerships. These higher dealership fees will likely cause dealerships to utilize some lending partners less or increase their pricing to all consumers. Similarly, dealers don’t always have enough room in the deal to include F&I product add-ons like vehicle service contracts. However, this opens up more opportunity for dealers to offer 0% financing to customers when these products cannot be included in the vehicle financing.
Lenders like Budco Financial can offer 0% or low-interest payment plan solutions designed to help OEMs, dealerships, and vehicle service contract administrators create new revenue streams by selling more extended service plan contracts. While interest rate hikes will influence automotive sales this year, consumers are still striving to attain the vehicles and features they want by accepting increasing costs and longer-term loans.