The auto sector has been one of the victims of the Federal Reserve’s aggressive rate hikes to quell inflation, which is at its highest level in 40 years.
According to experts, this monetary policy has increased the cost of credit, and more specifically the cost of car loans. Rising interest rates will cause consumers to reevaluate their decisions before quickly taking out a car loan, experts at Edmunds.com recently warned.
Interest rates on new and used vehicles are skyrocketing.
The average annual percentage rate (APR) of financing the purchase of a new car rose to 6.3% in October 2022, compared to 4.2% in October 2021, the highest APR for new vehicles since April 2019.
The average APR for the purchase of a used vehicle rose to 9.6% in October 2022, compared to 7.4% in October 2021, the highest since February 2010, says Edmunds.
More car buyers are opting for longer car loans to lower their monthly payments. Data from Edmunds shows that 34% of financed new car purchases in October 2022 had an average term of more than 73 months, compared to 27% in October 2017.
“The last time interest rates were this high, consumers could at least rely on lower car prices and increased inventory to soften the blow,” said Jessica Caldwell, Edmunds’ executive director. “That’s just not the case in this market.”
The Fed raised its benchmark lending rate by 50 basis points on Dec. 14, capping a year of seven hikes that added 4.25% to the Fed Funds rate. The Fed also stated that further hikes would be necessary. The central bank indicated that it will likely take the Fed Funds rate above 5%, implying at least another 0.75% cumulative hikes are needed before remaining at that level for most of next year.
This monetary policy continues to worsen the situation in the auto industry and has caused a crisis that could erupt in 2023.
“This morning I found out that something *extremely* alarming was happening in the auto market, especially auto loans,” wrote CarDealershipGuy, an anonymous account of a CEO of a car dealership group whose identity is unknown, on Twitter on Dec. 15.
Despite its mysterious owner, this account is highly followed in the industry because it is well-informed.
“I am now convinced that a huge wave of car repossessions is coming in 2023,” continued CarDealershipGuy.
The anonymous CEO explained that over the past two years, many people have taken out exorbitant car loans at a time when car values were too high. Due to the shortage of vehicles due to supply chain issues, these consumers had no choice but to buy cars that were too expensive.
Car valuations are falling
But car valuations are now plummeting. The value of some cars has plummeted, putting some buyers at risk. They owe banks more than what their car is worth.
“Every Friday I have a team meeting to recap our week,” said CarDealershipGuy. “This morning one of our general managers opened up DealerTrack – a portal that dealers use to communicate with car borrowers – and highlighted something very concerning.”
CarDealershipGuy added: “9 of our lending partners have begun to see AF of ‘open car provisions’ for consumers.”
This means the following: a consumer took out a car loan on an overvalued car in 2020/2021. In 2022, the value of the car will begin to decline. If the consumer wants to trade in the car, the dealer will refuse, because the consumer owes more than what the car is worth.
As a result, the dealer will ask the consumer to cover the difference, but the consumer cannot, creating what CarDealershipGuy calls “the perfect storm.”
“Dealer can’t sell the consumer a car, the consumer can’t buy a car. And, you guessed it, the lender can’t finance a car! Everyone loses!” said the anonymous CEO. But “lender knows most consumers are stuck in this situation and does the following: waives the open car provision, which means the lender lets the consumer buy the car knowing they already have an outstanding car loan with another Bank!”
Surely the lender knows that consumers who take out a 2nd car loan are much riskier and have a much higher risk of defaulting? Is it true? Yes, but the lender does it because they know the consumer will default on the different car,” the anonymous CEO added.
‘Biggest financial crisis ever’
According to CarDealershipGuy, that’s the “only way” lenders can finance cars and dealers can put cars on the road. However, this means “tons of seizures” ahead.
Elon Musk, the CEO of Tesla, and celebrity investor Cathie Wood agree that disaster is coming. They both responded to CarDealershipGuy’s thread warning of this potentially explosive situation.
“@ARKInvest is concerned about the impact of declining residual values on the $1 trillion auto loan market,” Woods noted Dec. 15. The shift in consumer preference towards electric cars will exacerbate this crisis.”
“Potentially the biggest financial crisis ever,” Tesla’s CEO added.