How High Will Auto Loan Rates Get?

On March 22, the Federal Reserve announced another increase in the federal funds rate, this time by 25 points (0.25%). The move marks the ninth increase in the federal funds rate, or federal rate, in the past year, bringing it to 4.75-5.00%.

While politicians and economic analysts have begun to debate the need for these federal rate increases, an auto industry already facing an affordability crisis will have to deal with the impact of even higher annual percentage rates (APRs). This has left many wondering just how high auto loan rates could get and when they might start to drop.

Latest Fed rate hike pushes funds rate near 20-year high

In mid-March 2022, the federal funds rate was in its lowest possible range of 0.00% to 0.25%. A little over a year later, that rate is inching toward its highest level in more than two decades.

The Federal Reserve began its current run of raising interest rates with a 25-point hike on March 17, 2022, with the goal of tackling runaway inflation. At that time, the Consumer Price Index (CPI), which measures inflation, was experiencing an increase of 8.5%. Raising the cost of borrowing is a common tactic to try to moderate the economy. Federal Reserve Chairman Jerome Powell said at the time, and has maintained ever since, that his goal is to bring the inflation rate down to 2%.

Since the initial interest rate hike, there have been eight additional hikes. During that same time, the CPI has fallen to 6%. While that is still well above Powell’s stated goal of 2% inflation, the president faces increasing scrutiny from politicians on both sides of the aisle in Washington.

At a hearing in early March, Sens. Elizabeth Warren (D-MA) and Sen. John Kennedy (R-LA) were among several who questioned Powell. Both expressed concern about a possible increase in unemployment as a result of the increase in interest rates. Later, Warren criticized Powell and continued to raise interest rates on “Meet the Press.”

“I don’t think you should raise rates,” Warren said. “I’ve been in the camp for a long time that these extraordinary fee increases that you’ve taken on these extreme fee increases are something you shouldn’t be doing.”

In the interview, Warren also said that he felt Powell “failed” as Federal Reserve chairman.

Car loan rates are likely to rise again

As borrowing costs for institutional lenders increased, they caused a significant increase in consumer auto financing rates. In February 2022, just before the first of the Fed’s recent rate hikes, the average interest rate for a 60-month new car loan was 3.99%. Just a year later, that average rose to 6.27%, an increase of 57%.

Increases in consumer auto loan rates have roughly kept pace with increases in the federal funds rate. That means the most recent increase will likely push consumer rates even higher.

This comes at a time when high finance rates are already fanning the flames of an affordability crisis for the auto industry. Coupled with supply chain issues that have increased prices, higher APRs have significantly increased the cost of buying a car. That has pushed some buyers to accept longer loan terms with higher interest costs, often in negative equity status. It has also pushed others out of the market entirely.

Another auto loan rate increase could exacerbate these trends by reducing consumer purchasing power. That would add even more cause for concern for an industry already facing uncertainty from multiple directions.

When is the next interest rate hike?

While the Fed’s latest rate hike is less dire than some of the previous hikes, it’s not likely to be the last. At a press conference on March 22, Powell indicated his determination to continue using the federal funds rate to try to control inflation, despite calls from policymakers and others to reassess the strategy.

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“Inflation is still too high and the labor market is still very tight,” he said. “Reducing inflation is likely to require a period of below-trend growth and some relaxation in labor market conditions.”

This means that the country is likely to see at least one more rate increase within the year. But it remains to be seen when the next rate hike will happen, or by how much it will be.

The Federal Reserve previously projected a “terminal rate” of 5.1%. A terminal rate is the upper threshold of the federal funds rate for a given strategy. In this case, it means that the Fed predicts that 5.1% – which represents a range of 5.00 – 5.25% – would be the limit for this round of rate hikes. An additional 25 point increase would put the funds rate in that range.

Currently, the Federal Open Market Committee (FOMC), which is the Fed’s monetary policymaking body, will meet six more times this year. The next rate hike, or at least the announcement of one, will probably take place at one of those times. These meetings are scheduled for the following dates:

  • may 23
  • June 13 and 14*
  • July 25 and 26
  • September 19 – 20*
  • October 31 – November 1
  • December 12 and 13

* Meeting associated with a Summary of Economic Projections

How high can auto loan rates get?

Auto loan rates are directly correlated to the funding rate. As the federal interest rate continues to rise, auto finance rates will rise along with it.

In the near term, borrowers can expect to see, or may already be seeing, a rise as a result of the Fed’s latest rate hike. The same can be said when the next rate hike comes around. That means average auto loan rates for new cars could very likely exceed 7% by the end of 2023, with other types of loans seeing similar increases. The last time this happened was between 2005 and 2008.

But while current rates are high in recent times, they are still historically low compared to almost any time more than 18 years ago. Prior to May 2008, average auto loan rates were only lower than the current rate during the nearly two-year span between 2003 and 2005.

When will auto loan rates drop?

There are other factors that influence auto finance rates, but the federal funds rate has the biggest impact by far. Just as it’s reasonable to expect APRs to go up along with the funds rate, it’s also reasonable to expect them to go down when that happens. And that could be relatively soon.

While Americans are likely to see another interest rate hike this year, it could be almost their last. As mentioned above, another increase would bring the interest rate to or beyond the established terminal rate of 5.1%. In December 2022, the Fed indicated that it expects the funds rate to fall to 4.1% by the end of 2024 after reaching the 5.1% mark in late 2023.

If that’s true and the federal interest rate starts to drop, auto loan rates should start to drop soon after. The result could be some relief for both consumers and companies in the auto industry.

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