Vehicles will go on sale at an AutoNation dealership on April 21, 2022 in Valencia, California.
Mario Tama | Getty Images
DETROIT – New cars are slowly becoming more widely available as supply chain bottlenecks finally ease. But now, increasing numbers of Americans may not want them or can’t afford them.
As the Federal Reserve aggressively raises interest rates to fight inflation, consumers are finding that the cost of financing a new car is suddenly much higher than it was earlier this year. This is expected to lower demand and put renewed pressure on the auto industry, which has been struggling with depleted inventories during the pandemic.
“The irony for the auto market is that the rapid movement in interest rates is reducing demand while the industry is poised to see volume pick up from supply-constrained, recession-like low levels,” Cox Automotive Chief Economist Jonathan Smoke wrote in a blog post Wednesday.
At the end of the third quarter, Cox Automotive noted that its new vehicle loan rate was 7%, up 2 percentage points for the year. The loan rate in the used car market rose by the same amount to 11%, according to Cox Automotive.
The higher cost of car financing comes as household budgets are already being squeezed by decades of inflation. That means many Americans may not be able to afford the new cars arriving at dealerships.
And financing costs are expected to continue to rise. Earlier this year, the Fed has aggressively raised interest rates on loans to 3% to 3.25% and indicated that it plans to raise rates further until the Fed’s benchmark rate hits 4.6% in 2023.
Automakers could offset the cost with financing deals and rebates, but the latter is something companies are reluctant to return to in the face of record profits.
Automakers had expected pent-up consumer demand to last in the short term due to shortages in the supply chain during the pandemic. But fleet and commercial sales, which aren’t as profitable, rose significantly in the third quarter, suggesting consumer demand could be softening.
And that’s despite inventories finally rising from record lows.
According to BofA Securities, total auto inventories rose to about 1.43 million units at the end of September, the highest since May 2021, and up 160,000 units from the end of August.
“We continue to believe the weakness in sales over the past year+ is due to limited inventory,” analyst John Murphy said in a note to investors on Wednesday.
But he also noted that inflation, weak consumer confidence and fears of a recession could slow demand.
Largely due to central bank action, Cox recently lowered its forecast for new car sales for the year to 13.7 million, from an already cut 14.4 million and a level not seen in a decade. At this rate of sales, lower production and profits could further strain the supply chain, leading to bankruptcies and further inventory disruptions, Smoke said.
In the meantime, however, the price increase in new car prices is slowing down. Average new vehicle purchase prices rose 6.3% in September to a record above $45,000, estimates JD Power. At the beginning of the year, prices had risen to record levels of 17.5% and 14.5%.
Prices keep going up
To make up for lower sales, automakers have focused on producing their most expensive vehicles, which are also their most profitable. Combined with rising interest rates, this is driving more car buyers to look at used cars.
Edmunds reports that the average amount financed for new vehicles hit a record $41,347 in the third quarter. That’s an increase from $40,602 in the second quarter and $38,315 a year ago. The average monthly payment for a new vehicle remained above $700 in the third quarter. Of those buyers, more than 14% committed to paying $1,000 or more a month for new vehicles — the highest level Edmunds has ever recorded.
“Stock can be a little skimpy, but it feels like maybe it’s getting better, not necessarily worse, which comes at an interesting time because now it feels like there’s actually a bit of trouble due to higher prices in demand, higher interest rates and whether or not we are in a recession,” said Jessica Caldwell, Executive Director of Insights at Edmunds.
Cox Automotive economist Charlie Chesbrough said he doesn’t expect new car prices to ease anytime soon, if at all, as automakers promise to keep leaner inventories to boost profits.
“I don’t know if there is a return to normal. I think we’re in a new normal right now,” he said.
Prices in the used car industry are falling, but rate hikes could offset this depending on the term.
After peaking in January, Cox Automotive’s Manheim Used Vehicle Value Index, which measures the prices of used vehicles sold at its US wholesale auctions, fell 13% through mid-September. But prices remain elevated from historical levels.
The median price of a financed vehicle is over $31,000, according to Edmunds, a level closer to new vehicle prices than used cars and trucks.
“There just aren’t many good options,” Caldwell said. “Used really doesn’t present itself as a good option unless you can find something with a lower interest rate.”