Rising Interest Rates and Car Prices Drive Record Loan Debt: An Analysis of the Automotive Industry.
New Car Shoppers Pay Record Prices and Loans, Teetering into Negative Equity
The U.S. car market has witnessed an unprecedented surge in car loan delinquencies, with many car buyers turning upside down on their loans. Experts attribute this trend to high-interest rates, soaring new car prices, and cooling used car values. While the U.S. economy is likely to avoid a recession this year, high-interest rates instituted by the Federal Reserve threaten to worsen the situation for auto loan borrowers.
New Car Prices and Interest Rates: The Double Whammy Fueling Negative Equity
According to data from Edmunds, the average interest rate on new car loans rose to 6.5% in Q4 2022 from 4.1% a year earlier. The rising interest rates and high new car prices mean that borrowers owe more and are taking out longer, more expensive loans to finance their purchases. In Q4 2022, the monthly payment on new car loans surged to $717, up from $659 the previous year. Nearly 16% of new car borrowers are paying more than $1,000 a month, also a record.
The average price for a new car in February 2022 increased by 4.8% from the previous year to $46,229, the highest average in history. With no signs of prices cooling down, auto dealers will likely continue benefiting from the trend of selling more new vehicles. In February 2022, new car shoppers were estimated to spend $42.0 billion on new vehicles, another record.
Seven-Year Car Loans: The New Normal?
While dealerships may be making more sales, their financial arms are experiencing a surge in requests for longer-term loans as buyers look to reduce their monthly payments. According to Experian, in Q3 2022, 20% of new car loans were at least seven-year or 84-month commitments. In addition, used car buyers are also getting in on the action, with a corresponding 11% of borrowers agreeing to seven-year loans.
However, with a seven-year loan, four to five years into the agreement, borrowers now have cars worth less than what is owed on the loan. For owners looking to trade in the car for a new one, this means rolling the outstanding debt from their old loan onto the new one, starting the cycle of negative equity all over again.
- According to J.D. Power, the U.S. auto industry is on track to deliver year-over-year sales growth alongside record transaction prices and record consumer expenditures for February.
- With supply constraints lifting, dealerships will sell fewer cars above MSRP than during the pandemic. In July 2022, 48% of vehicles were sold above MSRP, compared to 31% now, according to J.D. Power.
- Experts believe the trend of longer-term loans will likely continue as buyers look to reduce their monthly payments amid rising new car prices and interest rates.
The U.S. car market experienced a surge in 2022, with car buyers paying record-high prices and taking increasingly long loans to finance their purchases. The double whammy of high new car prices and high-interest rates has led to car buyers teetering into negative equity, with many finding themselves owing more than the car is worth. While dealerships are making more sales, their financial arms and auto loan borrowers are experiencing the negative consequences of these trends.
The U.S. car market has undergone unprecedented changes, with record-high prices and interest rates making it increasingly challenging for buyers to afford new cars. As a result, car buyers are taking on ever-longer loans to offset high monthly payments, setting them up for negative equity in the future. Despite economic headwinds, the auto industry is set for year-over-year growth with record transaction prices and recorded consumer expenditures, at least in February 2022. Dealership financial arms are, for now, capitalizing on the trend of longer-term loans, but this may change in the long run, resulting in a more complex and significant financial burden for borrowers.