The auto sector is one of the victims of the aggressive interest rate hikes by the Federal Reserve to crush inflation, which is at its highest in 40 years.
According to experts, this monetary policy has increased the cost of credit, and more particularly, the cost of car loans. Rising interest rates will make consumers reevaluate their decisions before quickly jumping into a car loan, experts at Edmunds.com recently warned.
“Interest rates for new and used vehicles are skyrocketing”, the research firm found.
The average annual percentage rate (APR) for financing a new vehicle purchase climbed to 6.3% in October 2022, compared to 4.2% in October 2021, the highest new vehicle APR since April 2019.
The average APR for a used vehicle purchase climbed to 9.6% in October 2022, compared to 7.4% in October 2021, the highest since February 2010, Edmunds says.
More car shoppers are opting for longer auto loan terms to lower their monthly payments. Edmunds data shows that 34% of financed new car purchases had an average loan term of 73+ months in October 2022, compared to 27% in October 2017.
‘Alarming’ Situation
“The last time interest rates were this high, consumers could at least rely on lower vehicle prices and a greater range of inventory to soften the blow,” observed Jessica Caldwell, Edmunds’ executive director of insights. “That simply isn’t the case in this market.”
The Fed on Dec. 14 raised its benchmark lending rate by 50 basis points, capping a year of seven hikes that have added 4.25% to the Fed Funds rate. The Fed also stated that further increases would be needed. The central bank indicated that it will likely take the Fed Funds rate past 5%, implying at least another 0.75% in cumulative hikes, before holding at that level for most of next year.
This monetary policy continues to worsen the situation in the automobile industry, and has created a crisis that could explode in 2023.
“This morning I discovered something *extremely* alarming happening in the car market, specifically in auto lending,” CarDealershipGuy, an anonymous account held by a CEO of a car dealer group whose identity is unknown, wrote on Twitter on Dec. 15.
Despite its mysterious owner, this account is highly followed in the industry because it is well informed.
“I’m now convinced that there is a massive wave of car repossessions coming in 2023,” CarDealershipGuy continued.
The anonymous CEO explained that over the past two years, many people took out exorbitant loans on cars, at a time when car values were inflated. Because of the shortage of vehicles due to supply chain problems, these consumers had no choice but to buy cars that were overpriced.
Car Valuations Are Plummeting
But car valuations are now plummeting. The value of some cars has sharply declined, putting some buyers at risk. They owe banks more than what their cars are worth.
“Every Friday I conduct a team meeting to recap our week,” CarDealershipGuy said. “This morning, one of our general managers opened up DealerTrack — a portal that dealers use to communicate with auto lenders — and highlighted something very concerning.”
CarDealershipGuy added: “9 of our lending partners have started WAIVING ‘open auto stipulations’ for consumers.”
This means the following: a consumer took out an auto loan in 2020/2021 on an overvalued car. In 2022, the value of the car starts declining. If the consumer wants to trade the car in, the dealer will decline, 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 can’t, causing then what CarDealershipGuy calls “the perfect storm.”
“Dealer can’t sell consumer a car, consumer can’t buy a car. And, you guessed it, lender can’t finance a car! Everybody loses!” said the anonymous CEO. But “lender knows that most consumers are stuck in this situation, and does the following: Waives the open auto stipulation, meaning, the lender lets the consumer buy the car knowing that they already have an open auto loan with another bank!”
“Surely the lender knows that consumers that take out a 2nd auto loan are much riskier and have a much high risk of default? Right? Yes, but the lender does it because they know that the consumer will default on the other car,” the anonymous CEO added.
‘Biggest Financial Crisis Ever’
Per CarDealershipGuy, that’s the “only way” lenders can finance cars and dealers can put cars on the road. However this means “tons of repossessions” ahead.
Elon Musk, Tesla’s CEO, and celebrity investor Cathie Wood agree that disaster is coming. They both responded to CarDealershipGuy’s thread, warning of this potentially explosive situation.
“@ARKInvest has been concerned the impact of declining residual values on the $1+ trillion auto loan market,” Woods commented on Dec. 15. “Most of these loans back gas-powered vehicles. @GuyDealership explains that the crisis is underway. The consumer preference shift toward EVs will exacerbate this crisis.”
Musk agreed.
“Potentially, the biggest financial crisis ever,” Tesla’s CEO added.
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