The Fed is making new cars something only the wealthy can afford.
On Nov. 2, the Federal Reserve raised interest rates for the fourth time in seven months. The move raises the rate banks charge each other for overnight loans, requiring them to raise interest rates on the loans and credit cards most consumers use to fund big purchases.
The Fed has moved the rate by a total increase of 375 basis points this year — a rate of change not seen since 1981.
Further increases may be coming, but the Fed signaled that they would likely be smaller and further apart.
““With rates expected to go even higher and stay there for at least the duration of 2023, the auto market will become more dependent on cash-rich, higher-income, and higher credit-tier consumers.””
The Fed made the move to try to rein in inflation on the theory that limiting big-ticket purchases will slow the growth of prices in all sectors of the economy. But this isn’t a controlled experiment with no other inputs.
The car market is reeling from two unusual years. Higher interest rates crash into that already-changing market. This collision may result in working people struggling to buy new cars, and automakers aiming their products at the wealthiest buyers.
As Cox Automotive Chief Economist Jonathan Smoke explains, “Living with restrictive rates for more than a few months will have long-term implications for the industry and the country.”
Read more: Why the car market might be ‘the harbinger’ of when the Fed can pivot
Some buyers squeezed out
“As a result of higher rates, consumers who are most payment sensitive have been falling out of the market,” Smoke says. Subprime and deep subprime loans, he says, are “disappearing.”
Through October, the weighted average auto loan rate across all loan types has increased by 2.8 percentage points to 10.6%. That raises the average car payment by more than 8% due to interest alone — and interest is far from the only thing elevating car payments.
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.
“No new vehicle being sold today can be financed with rates at that level to produce an affordable payment,” Smoke says.
“Fed rate hikes are making new cars a luxury — now even the lowest price cars are out of reach for many, and automakers are aiming their products at the richest buyers.”
For a household making $50,000 a year, a $400 a month car payment consumes nearly 10% of their gross income.
The least expensive new car in America for most of 2022 was the Chevy Spark. Factoring in tags, title, and assuming a 10% down payment, a Spark would now cost the average buyer more than $400 a month.
That pushes the least affluent buyers into the used car market. But things aren’t much better there. “In today’s market, subprime buyers are mainly limited to vehicles that are 6-9 years old and with at least 75,000 to more than 120,000 miles,” Smoke says.
Those cars can be expensive to own because they often need constant repair.
Automakers focusing on wealthier buyers
If you were paying close attention, you noticed that we said the Chevy Spark “was” America’s least-expensive new car. Chevrolet recently discontinued the Spark. Hyundai HYMTF, +0.18% did the same with its inexpensive Accent.
Cheap cars are disappearing.
“Before the pandemic, the auto industry was already shifting towards more expensive vehicles with a move to more trucks, SUVs, and luxury vehicles at the expense of smaller, more affordable sedans,” Smoke says.
See: 10 cars that are being discontinued this year (and there could be bargains here)
When a microchip shortage left them unable to build as many cars as they’d like, the manufacturers used the chips they could find to produce their most profitable cars — primarily expensive vehicles in expensive configurations.
The Fed’s move, Smoke says, will force automakers to double down on that strategy. “With rates expected to go even higher and stay there for at least the duration of 2023,” he says, “the auto market will become more dependent on cash-rich, higher-income, and higher credit-tier consumers.”
The companies that build our cars will have to “focus on that demand pool” since high earners will be the only buyers able to drive off a dealership lot in something new.
The affordability problem, Smoke says, is “not the Fed’s fault” but “a side effect” of its attempts to control inflation.
Also see: The cost of car insurance keeps going up, and it’s likely to get worse — here’s why
But that effect, combined with the microchip crisis, will snowball. “Transportation in the U.S. is heavily dependent on personally owned vehicles. And unfortunately, an increasing share of the population is running out of options for affordable transportation,” he concludes.
This story originally ran on KBB.com.