Car loan cost surge pressures manufacturers to reinstate discounts

Rising borrowing costs exacerbated by recent turmoil in the banking sector have sidelined some buyers in the US new car market, putting pressure on manufacturers to discount vehicles.

Cars have become increasingly unaffordable after shortages over the past two years forced consumers to pay at or above sticker prices. The Federal Reserve’s efforts to curb inflation have now driven the average interest rate on a new car or truck loan to 8.95 per cent, up from 5.66 per cent a year ago, according to Cox Automotive, which provides services to car dealers.

This month’s failures of Silicon Valley Bank and other US banks have also prompted other lenders to tighten access to credit in a new car market where more than eight in 10 buyers finance their purchases.

The turmoil has made banks “acutely aware of the risk that they are potentially dealing with and essentially are trying to insure that they are getting a risk-adjusted return”, said Jonathan Smoke, chief economist at Cox Automotive.

The financial squeeze on consumers is bringing discounts back to dealer lots. Discounts, which can take the form of leasing deals, special financing rates or cash rebates, averaged about $1,474 per vehicle in February or 3 per cent of the average transaction price. While well below historical levels of 10 per cent, it was the highest level in a year.

“The first domino to fall is really the dealer mark-ups we saw over the past two years,” said Fitch Ratings analyst Stephen Brown. “We’re already seeing a lot of that start to go away.”

Prices for new cars and trucks remain historically high. In February the average transaction price — how much a buyer paid, including any discounts — was up 5 per cent compared to a year earlier, to $48,763. But the price had slipped 1 per cent from January, according to Cox Automotive.

Elevated car prices have combined with higher interest rates to push up borrowing costs. For a six-year loan on a $45,000 vehicle, Barclays analyst Dan Levy calculated the average monthly car payment had risen from $702 to $748 between the fourth quarters of 2021 and 2022.

Costs have pushed some riskier subprime borrowers out of the market. They represent just 5 per cent of the market for new cars and trucks this year, according to Cox Automotive data, down from 14 per cent in 2019.

Kristy Elliott has seen the impact of rising borrowing costs at Sunshine Chevrolet, a dealership she runs in Asheville, North Carolina. Customers are more “skittish” about larger payments, including ones who were unconcerned last year “because the rates kept increasing on a pretty quick clip”.

“It’s not that they can’t afford a car, but no one likes to pay interest,” Elliott said.

In February, two lenders that served customers of Sunshine Chevrolet abruptly stopped offering loans without giving a reason, Elliott said, forcing the dealership to scramble to continue offering favourable terms. It has relied on GM Financial, the captive arm of the carmaker, to provide customers with rates like 4.99 per cent on a used vehicle.

“They actually stepped up and offered some very competitive rates,” she said. “They sent us an email a couple weeks ago right when SVB failed, just stating that they are financially very healthy, . . . that we don’t have to worry about losing them as a partner.”

Yet plenty of buyers financing new cars and trucks will pay far more. Ally Financial, a market leader in automotive finance, estimated that car loans originated in the fourth quarter of 2023 will yield 9.6 per cent, compared with 7.4 per cent a year before. The bank expects bad debt to rise to 2.2 per cent of average loans outstanding by the fourth quarter, compared to a historical norm of 1.6 per cent.

Analysts say that carmakers need to manufacture more of their inexpensive models to sustain strong sales. When parts shortages capped how many vehicles they could produce, carmakers focused on making the most expensive versions of their priciest cars and trucks and had no reason to discount their products.

General Motors said the company continued to see strong demand for its products and has “been able to grow our US market share with strong pricing”. Ford has predicted that average transaction prices will decline by 5 per cent by the end of the year. John Lawler, Ford’s chief financial officer, told a conference last month that “there’s room to move on dealer margins”, and he sees discounts ticking up in the second half of the year.

While carmakers right now were gunning to sell as many vehicles as possible at elevated prices, the pricing environment was poised to worsen for them, said Tyson Jominy, JD Power’s vice-president of data and analytics.

“Gravity will win,” he said. “Eventually prices will come down. The fact that they’re going sideways in the first quarter, it just means it will be later, and potentially the fall greater.”