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How the Fed’s rate hike will affect auto loans

Adding to the rollercoaster news cycle this week, the Federal Reserve raised its target federal funds rate by half a point. According to Edmunds Insights executive director Jessica Caldwell, this is the biggest rate hike in more than 20 years. And while it may curb rising inflation, it will squarely hit the wallets of new and used car buyers.

“The average monthly payment for a used vehicle purchased in April was a record $543 (and up 20% year over year!) with an average annual percentage rate of 8%,” said Caldwell said Thursday. “Today’s rate hike will force used buyers into older vehicles to keep payments within an affordable range.

As we already know, the prices of cars, SUVs and trucks are steadily increasing for several reasons. Supply has been the big issue as parts are hard to come by – even more so since Russia invaded Ukraine – and chip shortages continue to plague us. A month ago, Edmunds reported that the average monthly payment for new vehicles purchased in the first quarter of 2022 is expected to ring in at $648, which is the highest level Edmunds has ever recorded. Compare that to a monthly payment of $639 at the end of 2021 or $575 a year ago and you’ll see the path we’re on. Used car prices are not far behind at $538, down from $432 in the first quarter of 2021.

Now we can superimpose the rise in interest rates, which will affect the borrowing rate. Edmunds’ Caldwell explained why it’s different this year.

“In the past, interest rate hikes didn’t affect the new car market significantly because automakers subsidized many loans,” Caldwell told me. “Automakers are still subsidizing many loans, hence the average annual interest rate for a new vehicle financed at a dealership. That said, since inventory is so tight right now, automakers are less motivated to offer low-interest loans because it’s technically an incentive program.”

The rate increase will strengthen the new-vehicle buyer base of high-income buyers, Caldwell said, but the biggest effect will ripple through the used-car market.

“Given that used car prices are already at record highs, this increase will only make this market more expensive, and buyers will be forced to refrain due to affordability or purchase a vehicle older to keep payments within an digestible range,” she said.

That’s great news if you’re a bank, I guess. Otherwise, it’s going to be difficult for auto buyers for some time to come.

• Car loans