Earlier this month, the Federal Reserve increased its interest rate by a quarter of a point, and signaled they planned six more increases throughout the year. In response, banks with large auto loan portfolios raised their prime rates from 3.25 percent to 3.50 percent. The theory behind this is relatively straightforward. By raising the federal funds rate a domino effect takes place, slowing demand for goods and tapping the brakes on inflation. Whether directly or indirectly, a number of borrowing costs for consumers will also rise.
Prices for new and used vehicles have skyrocketed so much in the past year that an increase in interest rates may seem like small potatoes. The average interest rate on new car loans was 4.39 percent in February, relatively flat from a year ago, according to Dealertrack. The average for used vehicles was 7.83 percent in February, down from 8.25 percent. Car buyers taking out loans for a new vehicle borrowed an average of $39,721 in 2021, an increase of over $4,000 from a year earlier, according to Experian. As a result, monthly loan payments hit a record high of $644.
Car loans tend to track against the five-year Treasury, which is influenced by the federal fund rate. But the rate a consumer pays is based on credit history, the type of loan, down payment, type of vehicle and other factors. Those buyers with poor credit could pay more than 20 percent over the prime rate. For a consumer qualifying at the prime rate, a quarter point increase on a $40,000 loan is about $5 a month, or another $300 over the life of a five-year loan. For a buyer at subprime or worse, a quarter point increase could make a significant difference on the type of vehicle, the terms of the loan or even a “no-go” decision to purchase a vehicle.