By Sean Tucker
A shortage of microchips prompted automakers to use the chips they had to make their most profitable cars: luxury vehicles. Now they will double down on that strategy.
The Fed is making new cars something only the rich can afford.
On November 2, the US Federal Reserve raised interest rates for the fourth time in seven months. This move increases the interest rate that banks charge each other for overnight loans, forcing them to raise interest rates on the loans and credit cards that most consumers use to fund large purchases.
The Fed has hiked interest rates by a total of 375 basis points this year – a rate of change not seen since 1981.
More increases could come, but the Fed signaled they were likely to be smaller and more widely spaced.
The Fed took the move to try to curb inflation, based on the theory that limiting bulk purchases would slow price growth across all sectors of the economy. But this is not a controlled experiment without other inputs.
The car market is reeling from two unusual years. Higher interest rates are tumbling into this already changing market. This collision can cause working people to struggle to buy new cars and automakers to target their products to the wealthiest buyers.
As Cox Automotive Chief Economist Jonathan Smoke explains, “Living with restrictive interest rates for more than a few months will have long-term implications for the industry and the country.”
Read more: Why the auto market could be “the harbinger” of when the Fed can pivot
A few buyers crowded out
“Due to higher interest rates, the most payment-sensitive consumers have left the market,” says Smoke. Subprime and deep-subprime lending, he says, is “disappearing.”
Through October, the weighted average interest rate on auto loans across all loan types rose 2.8 percentage points to 10.6%. That increases the average car payment by more than 8% from interest alone — and interest is far from the only thing driving up car payments.
In October, a deep subprime borrower with a credit score below 580 saw an average interest rate of 18.2% on a new car loan and 21.8% on a used car loan.
“No new vehicle sold today can be financed at rates at this level to make an affordable payment,” says Smoke.
For a $50,000-a-year household, a $400-a-month car payment consumes almost 10% of their gross income.
The cheapest new car in America for most of 2022 was the Chevy Spark. Factoring in tags, title, and a 10% deposit, a Spark would now cost the average buyer more than $400 a month.
This is pushing the poorest buyers into the used car market. But it’s not much better there. “In today’s market, subprime buyers are mostly limited to vehicles that are 6-9 years old and have at least 75,000 to more than 120,000 miles,” says Smoke.
Owning these cars can be expensive as they often require constant repairs.
Automakers are focusing on wealthier buyers
If you were paying close attention, you noticed that we said the Chevy Spark was America’s Least Expensive New Car. Chevrolet recently discontinued the Spark. Hyundai did the same with its budget Accent.
Cheap cars are disappearing
“Even before the pandemic, the auto industry was shifting towards more expensive vehicles with a shift to more trucks, SUVs and luxury vehicles at the expense of smaller, more affordable sedans,” Smoke says.
See: 10 cars phasing out this year (and there might be bargains here)
When a shortage of microchips left them unable to build as many cars as they wanted, manufacturers used whatever chips they could find to produce their most profitable cars – mostly expensive vehicles in expensive configurations.
The Fed’s move, Smoke says, will force automakers to double down on that strategy. “As interest rates are expected to go even higher and stay there for at least 2023,” he says, “the auto market will become more dependent on solvent consumers with higher incomes and better credit ratings.”
The companies that build our cars need to focus on this pool of demand, as high earners will be the only buyers able to leave a dealer lot in something new.
The affordability problem, Smoke says, is “not the Fed’s fault” but “a side effect” of its attempts to control inflation.
Also Read: Car Insurance Costs Keep Rising And It’s Probably Getting Worse – Here’s Why
But this effect, combined with the microchip crisis, is snowballing. “Transportation in the US is heavily dependent on private vehicles. And unfortunately, an increasing proportion of the population are running out of affordable transportation options,” he concludes.
This story originally ran on KBB.com
(ENDS) Dow Jones Newswires
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