Moody’s Analytics data shows the average auto loan rate for a 48-month new-car loan surged from 4.87% in January 2022 to 7.4% in November 2023 as used-auto loans reached 11.6%.  -  IMAGE: Pexels/Kostas Dimopoulos

Moody’s Analytics data shows the average auto loan rate for a 48-month new-car loan surged from 4.87% in January 2022 to 7.4% in November 2023 as used-auto loans reached 11.6%.

IMAGE: Pexels/Kostas Dimopoulos

The combination of high interest rates, record car prices and inflation has strained many American consumers financially. A growing number of people struggle to meet car loan payments, possibly pointing to wider economic issues, says Will Holleman, sales director, auto, at Equifax.

He cites the top challenges before auto retail as high interest rates whose future is uncertain, rising auto loan delinquencies, and increasing auto loan balances.

Charlie Wise, head of global research and consulting at TransUnion, also sounds a warning about the state of the consumer credit market. He expresses concerns about consumers’ high debt loads and the growing auto loan delinquency rate.

Both shared their insights about what auto retailers and lenders can do to guide consumers into car loans they can afford.

Interest Rate Rollercoaster

For the past eight years, Holleman has been with Equifax's Auto division, where he has engaged with a diverse array of auto lenders and retailers. He earlier amassed six years in dealership sales and finance. Throughout his career, he’s seen interest rates rise and fall as swiftly as changes in the wind or weather. But in every case, he says the auto retail industry adjusts.

“During COVID we saw interest rates as low as zero percent, with incentives, because it was almost impossible to keep cars in stock,” he says. “People would order vehicles, and they would sit on the lot one or two days and then move. Demand was that high.”

But over the last two years, demand for vehicles has cooled as interest rates have heated up. In fact, a report by Moody’s Analytics says the average auto loan rate for a 48-month new-car loan surged from 4.87% in January 2022 to 7.4% in November 2023 as used-auto loans reached 11.6%.

“Because of record prices and high interest rates, we’ve seen a lot of voluntary removal from the auto retail space,” Holleman says. “Those people who didn’t need to buy a car for the last two years didn’t buy a car. … Now we are not seeing cars fly off the showroom floors like we did [during the pandemic.]”

Franchise dealers, he adds, are very reliant on programs offered by manufacturers and captive lenders. “Dealerships love it when people are coming in and there is zero-percent interest and a $5,000 rebate. But the days of coming in and getting $9,000 off MSRP and a $300-a-month car payment are gone, not just because of higher interest rates but because of the price of vehicles. The rebates also are not there.”

The Boost in Delinquencies

A fourth-quarter YCharts summary of U.S. auto loans that were delinquent by 90 days or more shows delinquency rates are up, hitting more than 4%.

Holleman says the increase in delinquencies is showing no sign of slowing. “It’s an issue that could plague us through the rest of 2024.”

Quarterly Equifax business reviews with lenders have shown that, “nearly every lender we work with is dealing with increased delinquencies, which has put a huge stress on their collection efforts,” Holleman says. “Lenders have shrunk their ‘buy box,’ meaning they are being more diligent about the consumer they lend to, the terms they offer and the rates they offer.”

The trend has strained dealerships. “The No. 1 goal of dealerships is to sell a car and get their customers into a loan,” Wise says. “But now we have lenders being a lot more stringent about the loans they buy, which can put dealerships into a really difficult position.”

Despite increasing delinquencies, Wise says TransUnion research shows a lower default rate on new-vehicle loans compared to used-car loans. “The overall increase in auto delinquencies has been driven by the used-vehicle space.”

Wise says the recent trend of people paying more than a used car is worth is partly to blame.

Holleman agrees, and said Equifax shows consumers who bought cars during the pandemic, when prices were elevated, now find themselves upside down on their loans and heading toward delinquency. Dealers, he says, might prevent delinquency by getting them into a different car or a more manageable payment. “But it’s hard to finance that inequity,” he says.

Understand Where Consumers Are

One immediate action dealers can take is to calculate consumers' financial stability before approving loans, Wise says.

One critical area of note is credit card debt. TransUnion research shows the average consumer holds $6,400 in credit card debt.

“That is the highest margin we have ever seen,” he says. “Consumers have been impacted by record inflation, which thankfully has come down. However, even at 2% inflation, it’s still difficult. The price increases we saw over the last couple of years are sticking.”

He says that rent and mortgage payments are higher, groceries cost more, and utility payments have soared. “That is putting a strain on a portion of people’s wallets, and they are turning to credit cards to bridge that gap.”

Higher vehicle prices and interest rates create more pressures, he adds.

“The cost to own a vehicle is at record highs. This has become a much larger bill for consumers to pay each month as they struggle with balancing everything else that comes out of their wallets.”

The remote work trend has also impacted which bills consumers pay first. In the past, Wise says consumers covered their auto loans before their mortgage payments because they needed a vehicle to get to work.

“Today, consumers prioritize paying their mortgage before paying their auto loan.”

In this marketplace, dealers must adjust their strategies, says Holleman, who underscores the need to gather complete and accurate information on credit applications. Equifax research has revealed that consumers are increasingly misrepresenting their financial information, he says.

“Inaccurate information can lead lenders to make adverse lending decisions. Dealers should do their best to make sure the information on the credit app that they send out to lenders is accurate because that gives them the best chance of selling the vehicle. It also helps consumers secure the best rates and loan terms and increases their chances of driving away with that vehicle.”

Soaring Loan Balances

Moody’s Analytics reports that auto loan balances have increased by 0.8%, reaching $1.6 billion in the third quarter of last year, the most recent data available.

Loan balances increased most among people with poor credit scores, says Wise, who blames growing expenses of subprime financing, which has much higher annual percentage rates than loans to borrowers with better credit who get better financing terms and have slightly lower average balances.

Wise recommends that dealers and lenders gather data that goes beyond credit scores to evaluate loan applications because it will help them determine if the consumer has the ability to pay back their loan.

Both TransUnion and Equifax offer tools that examine the consumer’s financial picture over time. “Are they seeing a positive trajectory, or are they on a downward slope?” Wise says. “Understanding these trends helps determine what a consumer's real loan capacity is and who is going to be more resilient versus more vulnerable.”

He emphasizes that taking care of the customer must go beyond selling the vehicle. “You want them to be successful and able to manage that debt. No one wants to repossess a car or work with a customer in collections. Using better data and analytics upfront can prevent that.”

According to Holleman, taking a consultative approach is key to getting customers into vehicles within their budgets. “Maybe they cannot afford to buy a 2024 Toyota Camry, but the dealer can get them into a 2018 Toyota Corolla,” he says. 

He also advises that dealerships partner with multiple lenders to enhance their ability to match customers with the right lenders. “There are so many things an F&I manager can do to make sure they select the right lender based on the customer’s criteria,” he says. “There are lenders who don’t like to finance electric vehicles, and lenders with restrictions on how old a vehicle is. Every lender has a certain niche. It’s up to the F&I person to understand that niche.”

Wise suggests auto lenders and dealerships also offer free credit-monitoring services as a long-term strategy. “When consumers with subprime credit scores start monitoring their credit, their scores improve. Consumers with a genuine interest in improving their scores realize they may be challenged today but that they can start on a path to improve their scores tomorrow.”

An Uncertain Future

It’s uncertain if the Federal Reserve will lower interest rates this spring, adding another complication to auto financing.

Wise predicts it will take a wait-and see-approach at its March meeting. “The Fed recognizes rates are high, but there is no urgency to lower them because the economy is still doing well. [Gross Domestic Product] continues to grow, and unemployment is almost unchanged. Everything looks healthy. From the Fed’s perspective, there is no urgency to bring things down until they are confident that they have inflation beat.”

Still, news reports suggest there is a high probability that the Federal Reserve will cut interest rates in 2024 to provide relief for financially strained Americans. “The Feds are on track to lower rates three times this year by a cumulative of 75 basis points,” Wise agrees. “But that will not start until later on in the year.”

The automotive retail industry would be affected by significant rate drops as vehicle loan payments become more affordable. This could increase demand for vehicles and vehicle refinancing, Wise says.

“Lower interest rates and prices would bring many people back into the market, so dealerships could see an influx of people who have been waiting to buy a car.”

But the truth of the matter, Holleman says, is that no one really knows how things will play out this year. “These are unprecedented times for the automotive industry. We are trying to navigate this day by day, week by week, and month by month. It’s been a tough couple of years, and I don’t think anyone is willing to say that 2024 will be a great year, but there’s some cautious optimism.”

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ABOUT THE AUTHOR

Ronnie Wendt is an editor at Auto Dealer Today.

Originally posted on Auto Dealer Today

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