Investing

Interest Rate Hikes Threaten A Fragile Car Industry

Douglas A. McIntyre

Published: June 14, 2018 7:01 am

Last Updated: January 11, 2020 10:22 pm

The U.S. car industry has posted a record-setting pace the last three years, with sales above 17 million per annum. The growth rate has slowed, and industry experts expected unit sales to taper off this year into next. New interest rate hikes by the Federal Reserve could accelerate the decline.

Part of the improvement in the car industry’s fortunes has been based on incentives, among which are zero percent financing for long periods of time, in some cases as much as 72 months. Owners can pay for vehicles over a period during which many people, historically, get a new car, or even two. The sugar high of low monthly payments has encouraged consumers to take on new-car ownership that they may not have done if interest rates had been higher.

Banks and car finance companies began to raise their borrowing rates years ago. To some extent, they knew the car interest rates that manufacturers charged were too low to be sustainable at a profitable level. Most of these lenders charge between 3.3% to 4%. That indicates that car companies were offering rates that compressed their margins. Higher interest rates sparked by the Fed will make zero- rate financing even more disadvantageous for them, which means “too good to be true” deals for buyers will go away.

The car industry is up against a traditional trend that made incentives necessary to their success. Cars last longer, because they are built better. The average American car has been on the road nearly 12 years. That means the need to buy a new car has dissipated, at least in terms of real necessity for consumers. But, why not get a new car, if the deals are good enough.

Higher interest rates will teach the car companies something their chief financial officers already know: Financing incentives were based on the benevolence of the Federal Reserve, but it has recently decided to be less generous