Higher interest rates are translating to record car payments among Americans borrowing money to purchase new vehicles.
Actions from policymakers at the Federal Reserve to tame inflationary pressures have led to the fastest increase of the target federal funds rate in decades, impacting interest rates across the economy and raising the cost of borrowing money for consumers and businesses. The average annual percentage rate on new financed vehicles increased from 5.7% in the third quarter to 6.5% in the fourth quarter, according to data from the car review website Edmunds, while the rate for used financed vehicles increased from 9% to 10%.
“At the onset of the pandemic, consumers benefited from low interest rates and elevated trade-in values, helping shield even the more questionable financing decisions from resulting in negative equity,” Edmunds Director of Insights Ivan Drury said. “But as we shifted toward an environment with diminished used car values and rising interest rates over the past few months, consumers have become less insulated from those riskier loan decisions, and we are only seeing the tip of the negative equity iceberg.”
Negative equity, which occurs when a debtor owes more money than an asset is worth, applied to 17.4% of new vehicle sales in the fourth quarter, marking an increase from 14.9% of sales in the third quarter. “Rapidly rising interest rates created an even greater barrier to entry for consumers who rely on financing,” added Drury, “which is the vast majority of car shoppers.”
Although the typical monthly car payment was $717 in the fourth quarter, constituting an increase from $659 in the previous quarter, the share of consumers paying $1,000 or more each month reached 15.7%, the highest reading on record. Average down payments surged to $6,780 from $5,921 over the same period as more consumers sought to avoid high rates.
Payments are unlikely to subside in the near future since minutes from the most recent Federal Open Market Committee meeting show that central bankers are prepared to take a “restrictive policy stance” on rising price levels for “some time.”
Supply chain pressures that continue to grapple the economy following the lockdown-induced recession have worsened surging vehicle prices. Average costs increased some 43% between February 2020 and September 2022, according to data from JPMorgan Research, which forecasted prices for used vehicles will adjust by falling as much as 20% this year.
Demand for automobiles still outpaces supply despite the advent of elevated interest rates, according to data from J.D. Power and LMC Automotive, which indicated that sales for new vehicles increased 9.6% between the fourth quarter of 2021 and the fourth quarter of 2022.
“While the inventory situation has improved modestly in the fourth quarter, supply remains well below the level at which consumer demand for new vehicles can be met,” J.D. Power Data and Analytics President Thomas King commented.
As inflation continues to outpace wage increases, rising price levels have prompted Americans to meet expenses by spending beyond their means. The portion of disposable personal income used to service consumer debt rose from 5.4% in the fourth quarter of 2021 to 5.8% in the third quarter of 2022, exceeding levels seen before the lockdown-induced recession, according to data from the Federal Reserve.