After a Tough Two Years, Auto Loan Conditions Are Finally Improving

This summer brought auto loan defaults, auto loan delinquencies and repossessions for many Americans as the Federal Reserve raised interest rates to the highest they've been in 22 years. The measure of borrowers with outstanding car payments from 30 to 89 days is back above pre-pandemic levels and defaults, when a lender determines the debt will not be paid, are now over 2 percent.

Wages have gone up in the past two years, but not as fast as inflation, according to the McNair Center for the Advancement of Free Enterprise and Entrepreneurship at Northwood University. Cars are also more expensive than they were five years ago, with an average transaction price $10,000 higher than in 2018. The biggest leaps in defaults have been from the subprime borrowers.

The Federal Reserve recently said the rejection rate for auto loans in June rose to 14.2 percent from 9.1 percent in February, which was highest level since it began tracking the stat in 2013. It said the probability of a loan getting rejected increased sharply as well.

"Interest rates are going up for loans because the Fed rate has been increased. With money more expensive, banks and institutions are getting more particular. Our ratings team has said that the changes reflect diminishing pandemic-related savings, inflationary pressures, aggressive loan growth, and lower used vehicle values," Stephanie Brinley, associate director of research and analysis at S&P Global, told Newsweek.

America arrived at this point because rates on auto loans are a product of bond yields, and the risk lenders are assessing on auto loan performance. The bond market is influenced by the Federal Reserve so when its rates increase, so do the rates on many types of loans. New auto loan rates were at all-time lows at the end of 2021. Since then, rates have increased.

"However, the Fed's rate policy impacts short-term rates, and auto loans are more affected by what longer-term rates like 5-year and 10-year Treasury yields are doing. This year, we've seen auto loan rates increase by about 1.5 percentage points this year, but the increase has been for various reasons," Jonathan Smoke, chief economist for Cox Automotive told Newsweek.

"Bond yields have risen about a point so far this year, so that's a key driver. Auto loan risk is perceived as higher with economic uncertainty, concerns about declining collateral values, and high auto loan delinquency rates," he said.

Smoke doesn't anticipate those rates will decline much in the short term, probably staying at this high level for another year or so. That is what the Federal Reserve is signaling. Then it comes down to what manufacturers do.

"Different manufacturers have different credit strategies and if they're trying to move metal they'll accept worse rates," Jill Louden, associate director of product management for S&P Global Mobility told Newsweek. "It depends on what pressure the automakers are getting from dealers. They know that cars depreciate as they sit and they understand what they need to do to move them off the lot."

In 2021 and 2022 auto loan prices and lack of supply contributed to inflation, but in 2023 new and used autos have played more of a disinflation role as demand has cooled and supply, especially of new vehicles, has improved.

"Wages have been seeing strong gains judged by historical standards and have seen very little slowing and certainly less deceleration in gains than the Fed would prefer to see. But in terms of consumer health and spending power, that's a good thing because we are back to wage and income growth exceeding inflation," said Smoke.

According to the experts this is more of a market hiccup than a sign of doom. Cox has seen auto loan decline rates this year that are higher than it has seen over the last three years but are still not at historic levels. They're also mostly in the used and subprime markets. For new buyers, average credit scores are ticking up.

"I think affordability is the main problem, and I don't think we will get much relief in the short term, with rates likely staying about where they are today. However, as consumers see strong income gains and vehicle prices are decreasing, at least affordability is no longer worsening. Price declines in used are helping improve demand for used vehicles this summer. Like rates, credit access should remain limited but at least not get worse as long as we don't see job losses starting and a recession unfolding," said Smoke.