Car salesmen call it “the payment walk,” when a customer wants a new vehicle but is walked instead to the used lot because they can’t qualify for a new-car loan.
With the Federal Reserve seemingly bent on more interest-rate hikes, it’s almost certain that more people will be taking that stroll.
The Fed raised rates a quarter percent in December, the third rate hike of 2017, and it’s broadcasting three more this year.
For would-be buyers with stellar credit, the impact hasn’t been substantial. But many with subprime credit scores of around 600 or below are now settling for cars that already have some miles on them, says Jonathan Smoke, chief economist for Cox Automotive.
Subprime buyers got substantially better rates even a year ago. The average subprime rate of 5.91 percent last year has jumped to 16.84 percent today, Smoke says. For a 60-month loan of $20,000, that means a monthly payment hike of more than $100, to $495.
“Their ability to qualify has changed dramatically,” Smoke says.
Used car sales are already up, and new-car sales have ebbed, says Bill Perkins, owner of a Chevrolet dealership in Taylor, a suburb of Detroit. Record new-car sales are on the way out.
“It’s going to affect everything,” he says.
It’s one reason that Cox Automotive lowered its U.S. auto sales forecast this year to 16.6 million, down from an expected 17.1 million in 2017.
Buyers with good credit, scores above 660, haven’t been greatly affected yet, says Melinda Zabritski, Experian’s director of automotive finance. A quarter-point increase is only around $4 per month in these cases, and rates of 4 percent or lower are still around. But as rates rise, Zabritski expects a broader downscaling trend.
Buyers with credit scores of 600 or lower make up about 20 percent of new-car sales. Prime credit buyers make up 61 percent. The rest are in a middle category called nonprime, according to Experian.
Auto loans on average have risen at a slower pace than the Fed’s short-term rate, largely because automakers subsidize loans to goose sales. Some remain at 0.
Automakers may desire higher rates, but they’re also fighting for sales in a declining U.S. market, said Jessica Caldwell, executive director of analysis for Edmunds.com.
Even small payment bumps for people with strong credit will have an impact, if only a psychological one, says Perkins. A $199 monthly lease goes over $200, or a $299 lease passes $300.
“People are going to take notice of that,” Perkins says.
Buyers are already steering toward extended loans to lower monthly payments, with the average at 69 months, according to Experian. The average vehicle loan is now $30,329, up $291 from a year ago.
Bradd Levin of Stamford, Connecticut, who runs a plumbing supply business, wanted to lease a vehicle to replace a 2011 Honda Pilot SUV. He knew interest rates had gone up, didn’t want a down payment, and was hoping a dealer would give him cash for the Pilot. He figured he wouldn’t be able to beat a lease payment of around $600 per month.
But a dealer cut the price of a new $44,500 Pilot to $39,800, offered 0.9 percent five-year financing through Honda, plus over $10,000 for his SUV. That brought his monthly payment to around $540, less than the lease. “Because the interest rate on the lease was so high, I ended up financing,” he said.
Levin’s deal would only be offered to someone with prime credit. Smoke, of Cox Automotive, thinks rising rates will force those with weaker credit into older used vehicles, or out of the market completely.
“There’s a point at which you just can’t keep moving to a lower-priced vehicle,” he said.