Interest Rate Hikes Put Car Loans Out of Reach For More Americans

Car loans have become more expensive since the Federal Reserve increased the prime interst rate in October and November 2022. The average interest rate on a car loan in October 2022 was 10.6%, almost double the cost of a loan in early 2022.

Interest rates are only part of the story, however. Cars are also more expensive now than they were before the pandemic, because automakers have been hit with supply chain difficulties. Ultimately, a combination of high prices and high interest rates might make new cars unaffordable for low- and middle-income families, at least in the short-term.

How The Fed Rate Affects Auto Loans

The interest rates set by the Federal Reserve can affect how much interest you are charged on an auto loan. Specifically, the Federal Reserve (Fed) sets the federal funds overnight rate which serves as the basis for the prime rate, which is the starting point for other interest rates. The prime rate is the most commonly used benchmark used by banks and other lenders when setting their interest rates for various products, such as credit cards, home loans, and auto loans.

Raising interest rates is believed to limit inflation, so at a time of record inflation in the US the Federal Reserve has been aggressive in raising interest rates. The Fed increased the Federal Funds Rate to 3.9% in early November, meaning it has now moved the target rate by 375 basis points (Bps) in 2022, the most in any year since 1981.

Federal interest rates don’t directly affect most auto loans, because the rate of interest on an auto loan is not normally linked to the prime rate. However, increased federal interest rates make it likely that auto loan providers will raise their prices.

We are already seeing that effect. Though the Best Auto Loan rates are still as low as 4%, but for customers with poor or limited credit it will likely dramatically increase the cost of a loan. In the last month the weighted average auto loan rate across all loan types has increased by 2.8 percentage points to 10.6%. People with low credit scores are likely to be hit hardest by these price increases. In October, a deep subprime borrower, with a credit score under 580, saw an average rate of 18.2% on a new-vehicle loan and 21.8% on a used-vehicle loan.

The Cost Of New Cars Is Rising

It’s important to put these interest rates in perspective. Though auto loans are now much more expensive than they were earlier this year, they are still much cheaper than they were ten years ago. The average rate for a car loan has fluctuated from an all-time high of 17.36% in late 1981 to an all-time low of 4.00% in late 2015. Interest rates have remained in the 4.00%–5.50% range for the entirety of the last decade, except for the last few months.

But interest rates are not the only factor making new cars more expensive. The purchase cost of new cars has also increased sharply during 2022, due to chip shortages and pandemic supply chain issues. The average price paid for a new car in September 2022 was above $48,000, after five consecutive months of increase.

Some analysts fear that these factors may mean that only rich families will be able to buy a new car in the short-term. As Jonathan Smoke, chief economist at Cox Automotive, has pointed out, the combination of interest rate increases and rising car costs now means that the least expensive new car available in the US – a 2022 Chevrolet Spark – will cost more than $400 a month to finance. And for many lower and middle-income families, that makes buying a new car an unaffordable luxury.