Car loans have gotten more expensive since the Federal Reserve raised interest rates in October and November 2022. The average interest rate on a car loan in October 2022 was 10.6%, nearly double the cost of a loan in early 2022.
But interest is only part of the story. Cars are also more expensive now than they were before the pandemic as automakers are hit by supply chain difficulties. Ultimately, a combination of high prices and high interest rates could make new cars unaffordable for low- and middle-income households, at least in the short term.
How does the Fed rate affect auto loans?
Interest rates set by the Federal Reserve can affect the amount of interest charged on a car loan. In particular, the Federal Reserve (Fed) sets the overnight interest rate, which serves as the basis for the benchmark interest rate, which is the starting point for other interest rates.
The base interest rate is the benchmark most commonly used by banks and other lenders when setting their interest rates on various products such as credit cards, home loans, and car loans.
Raising interest rates is believed to limit inflation, so the Federal Reserve has been aggressive in raising interest rates at a time of record US inflation. The Fed raised the federal funds rate to 3.9% in early November, meaning it has now raised the target rate by 375 basis points (bps) in 2022, the highest one-year rate since 1981.
Federal Interest Rates
Federal interest rates do not directly affect most auto loans because the interest rate on an auto loan is generally not tied to the prime rate. However, rising federal interest rates make it likely that auto loan providers will raise their rates.
We are already seeing this effect. While the best auto loan rates are still just 4%, for customers with poor or limited credit, borrowing costs are likely to increase dramatically.
Last month, the weighted average auto loan rate across all loan types increased by 2.8 percentage points to 10.6%. Those with low credit ratings are likely to be hit the hardest by these price increases.
In October, a deep subprime borrower with a credit score below 580 saw an average rate of 18.2% on a new car loan and 21.8% on a used car loan.
The cost of new cars are rising
It’s important to put these interest rates in perspective. Although car loans are significantly more expensive today than they were at the beginning of this year, they are still significantly cheaper than ten years ago. The average interest rate on a car loan has fluctuated from an all-time high of 17.36% at the end of 1981 to an all-time low of 4.00% at the end of 2015. However, interest rates have remained in the range of 4,00% to 5.50% over the last decade, except for the last few months.
But interest rates aren’t the only factor that makes new cars more expensive. The cost of buying new cars also rose sharply in 2022 due to chip shortages and pandemic supply chain issues. The average price paid for a new car in September 2022 was above $48,000 after five consecutive months of increases.
Finally, some analysts worry that these factors could mean that only wealthy families will be able to buy a new car in the short term. As Jonathan Smoke, chief economist at Cox Automotive, pointed out, the combination of rate hikes and rising car costs now means that the cheapest new car available in the US – a 2022 Chevrolet Spark – will cost upwards of $400 per car. Finance month. And for many low- and middle-income families, this makes buying a new car an unaffordable luxury.