Susan TomporDetroit Free Press
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One thing is for sure about September: Talk couldn't be any hotter when it comes to expectations that the Federal Reserve will finally roll out its first rate cut in years on Sept. 18. But how will that help move metal in Detroit?
The Fed's fight against inflation, which involved raising short term rates 11 times in nearly 18 months, contributed to a head-on collision for borrowers. Car buyers not only faced skyrocketing prices for both new and used cars, but those who took on car loans also got stuck paying significantly higher interest rates.
Car sales, though, kept moving along. Many had worried back in 2022 when the Fed first began raising interest rates that auto sales would tank. But vehicle sales held up despite higher auto loan rates, economists say, thanks to the pent-up demand for cars and trucks that developed during the pandemic when vehicle supplies were extremely limited.
Every borrower, including car buyers, could use a break now from extraordinarily high interest rates.
Just three years ago, the average payment on a new car was $597 a month on loans taken out in the second quarter of 2021; the average amount financed then was $36,634 on those loans, according to data released by TransUnion in early August.
Go back four years, and the average monthly payment was $576 in the second quarter of 2020, according to TransUnion, with the average amount financed around $36,619.
The average payment has jumped to $740 a month on loans taken out for new vehicles bought in the second quarter of 2024; the average amount financed was $41,344 on those new car loans.
We're looking at a nearly 28.5% hike in monthly payments on new cars and trucks in just four years, thanks to higher prices and higher loan rates.
How soon will car loan rates fall once the Fed pulls out the scissors?
Why car loan rates won't tumble soon
Not as soon as one might hope, unfortunately. Car loan rates could remain high longer than expected, in part, because lenders are trying to protect their bottom line as some struggling consumers fall behind making their car payments, according to Jonathan Smoke, chief economist for Cox Automotive.
And the Fed isn't going to be gunning it when it comes to cutting the federal funds rate. It could be a slower roll than many consumers would like to see. We're talking about a series of what many expect could be gradual rate cuts from now through next year, and likely into 2026.
By the end of 2026, the short-term federal funds rate might be down by as much as 2 percentage points to 2.5 percentage points after the Fed's rate cuts, Smoke said.
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The short-term federal funds rate is currently in the 5.25% to 5.5% range — and a series of rate cuts could bring the federal funds rate down to around 3% or so in two years.
Ultimately, down the road, Smoke said, consumers can look forward to auto loan rates that are 2.5 percentage points to 3 percentage points lower on new car loans. Used car loans might see a bigger drop because those rates are already significantly higher.
"Within the next two years we should get to a new normal of 7.5% to 8% rates on average for new (car) loans," Smoke said. "That’s far better than the near 10% we have been seeing this year, but it’s not the 5.8% average low we had in 2021."
The average car loan rates tracked by Cox Automotive reflect what consumers are paying for actual loans, based on their credit score and other factors.
To be sure, Smoke said, consumers could see some aggressive auto loan rates being offered at various times by the auto manufacturers to move new cars off lots at year-end or reduce built-up supply for some models at other times during the year.
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Don't bet on a bunch of 0% offers
A 0% car loan rate or a 2.99% promotion on new and pre-owned vehicles isn't going to be the norm here.
Smoke said those shopping for cars and trucks could see somewhat lower auto loan rates within two months of a Fed rate cut. Look for lower auto loan rates sometime in November or December if the Fed first cuts rates at its next meeting on Sept. 17 and Sept. 18. Some economists expect another rate cut at the Dec. 17 and Dec. 18 meeting, which also could drive auto loan rates lower.
Smoke expects that auto loan rates could be a quarter point to half a point lower by the end of 2024 and auto loan rates would fall at least another quarter point by February.
"By spring next year, auto loan rates could be at least a full percentage point lower," Smoke said.
All things being equal, lower interest rates on car loans overall would contribute to smaller monthly car payments for borrowers who lock in those lower rates. "A full percentage point decline reduces the monthly payment by about 3%," Smoke said.
Maybe instead of looking at a $740 a month car payment, a new car or truck buyer could be looking at a payment around $718 a month after just three or four rate cuts initially.
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Car and truck prices overall are likely to fall somewhat, Smoke said, as manufacturers offer more discounts and incentives to normalize supply.
"At the same time, consumers should enjoy 3% to 3.5% in income growth, so affordability will be improving substantially over the next two years as rates decline and stop being restrictively high," Smoke said.
Cox Automotive is expecting more sales growth in 2025 because of improving affordability. The forecast is for 4% growth in new vehicle sales in 2025, up from an estimate of just 1% growth in 2024.
Car loans don't track the Fed's rate cuts exactly
Auto loan rates don't mirror the short-term federal funds rate that's set by the Federal Reserve policy committee, known as the Federal Open Market Committee. Instead, car loan rates track longer term bond yields like 5-year and 10-year U.S. Treasuries.
Auto lenders will watch a variety of factors, including the bond market, the expectations for what the Fed does next and the overall financial well-being of consumers who are juggling high prices on groceries and rent, as well as much-inflated interest rates on their credit card debt.
If auto delinquencies remain elevated, Smoke warned, lenders will have more reason to be cautious and be more reluctant to quickly lower car loan rates in the upcoming months. Auto loan delinquencies, he noted, remain very high.
"Auto loan rates are likely to move down slowly," Smoke said.
Car loan rates went up to 7.82% from 3.86% in a few years
Go back to January 2020 before the COVID-19 pandemic hit, and the average five-year new car loan rate being offered by lenders was 4.6%. It even fell down from there to 3.86% in January 2022, before the Federal Reserve rolled out its first rate hike in March 2022, according to data from Bankrate.com.
Now, the average five-year rate for a new car or truck is 7.82% — that's up from 7.19% a year ago, according to Bankrate.com research. Bankrate's data is based on a survey of banks in large markets around the country, based on what is being offered directly to consumers with at least a 700 credit score. The data doesn't include dealer or manufacturer financing.
It's important for anyone shopping for a car loan to understand that your credit score plays a significant role in determining your interest rate. Other variables will influence that rate, too, including the lender, how much you need to finance, the length of the loan and overall economic conditions. Most consumers should review their credit score first, and shop around for a car loan, before heading to a dealership.
The average rate for a used car buyer with deep subprime credit — someone with a credit score in the range of 300 to 500 — was as high as 21.57% in the first quarter this year, according to data from Experian. But that average rate was but 6.8% for someone with top-tier credit.
The average rate for a new car buyer with deep subprime credit was 15.62% as of the first quarter of 2024, according to Experian data. But that average drops to 5.38% for someone with exceptional credit in the super prime range of 781 to 850.
Higher rates lead to higher payments, and more vulnerability for some. Even though many people are working, many are falling behind on their car payments, particularly younger borrowers and lower-income workers facing financial stress, according to the Federal Reserve Bank of New York.
Over the last year, about 9.1% of credit card balances and 8% of auto loan balances transitioned into delinquency, according to the Federal Reserve Bank of New York.
Auto loan delinquencies revved up as higher car prices put more stress on household budgets, according to a Federal Reserve blog called "Liberty Street Economics" in February. Auto delinquencies rose the most for borrowers in lower-income ZIP codes.
"Loans opened during 2022 and 2023 are, so far, performing worse than loans opened in earlier years," according to the Fed blog, "perhaps because buyers during these years faced higher car prices and may have been pressed to borrow more, and at higher interest rates."
"As the Fed starts cutting, and credit card interest rates decline," Smoke told the Detroit Free Press, "I expect consumer financial conditions to improve and auto loan delinquencies to then fall."
Lower rates overall, including lower rates on credit cards, should help consumers regain their financial footing if the jobless rate remains relatively low.
As that happens, he said, lenders would have more confidence in the economic outlook. And then consumers could see bigger declines in auto loan rates, as those rates catch up and surpass Fed rate moves.
What should we expect after the first rate cut?
As that old 1960s hit goes, it will be "See you in September" for the Fed's first move to lower interest rates.
But we've got many more rate cuts and months to go before we see substantially lower interest rates on credit cards, car loans and other loans.
"I expect six rate cuts through the end of 2025, each a quarter percentage point, putting the federal funds rate just below 4%," said Mark Zandi, chief economist at Moody's.
He expects auto loan rates to fall 75 percentage points through the end of 2025, putting the five-year car loan rate at close to 7%.
Zandi reiterated that auto loan rates are tied to intermediate term Treasuries, and thus won’t fall as much as the federal funds rate as the Fed cuts rates.
"Lower auto loan rates, lower vehicle prices, and stable gas prices will help to support more vehicle sales," Zandi said. "I expect new sales of 16.7 million in 2025."
"The economy should continue to perform reasonably well through the end of 2025," said Zandi, who puts the odds of a recession beginning in this period at 25%. Those odds are, he said, "a bit elevated from historical norms given the uncertainty created by the election and next year’s likely budget battles."
A few rounds of rate cuts, clearly, could help put more new cars on the road. But consumers will need to make sure to hold onto their jobs and not drive their credit scores into a ditch.
Contactpersonal finance columnist Susan Tompor:stompor@freepress.com.Follow her on X (Twitter)@tompor.
