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Understanding How Inflation Affects Auto Loan Financing

With inflation soaring to its highest in more than 40 years, many consumers are finding themselves struggling to pay for basic goods and services. According to the U.S. Bureau of Labor Statistics (BLS), the Consumer Price Index (CPI) climbed to a staggering 8.5% this year, meaning significant price hikes in food, gas, housing, and transportation.

how inflation affects auto loan financing

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Unsurprisingly, the spike hit virtually every corner of the economy, from grocery stores to nail salons. It’s also bad news for those shopping for cars. Inflation has an impact on the price of cars and the rate of auto loans, but that doesn’t mean it’s not a good time to head to the dealership.

How Inflation Affects Auto Loan Financing

Here’s everything you need to know about how inflation affects auto loan financing.

1) The Rising Price of Cars

While the CPI as a whole climbed to more than 8% recently, that’s a bunny hill in comparison to rises seen in the automotive sector, which skyrocketed well into the double digits. In the face of a growing microchip shortage and the war in Ukraine, vehicle prices continue to be a sore subject for shoppers.

Manufacturing and shipping limitations threw supply and demand out of whack, resulting in sky-high prices. According to the BLS, new cars cost 12.6% more than they did at the same time last year, while used cars cost 35.3% more than they did at the same time last year. This has caused many buyers to delay or hold off altogether on buying a new vehicle.

the rising price of cars

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2) How Inflation Affects Interest Rates

When researching anything regarding inflation in the United States, you must first understand the basic principle of the Federal Reserve and its benchmark rates. The Federal Reserve (Fed) is the central banking system of the United States and the entity that sets benchmark lending rates upon which the private banks base their interest rates.

When inflation grows rapidly like it is right now, the Federal Reserve may take steps to help slow it. Raising interest rates on “riskier” assets — mortgages, car loans, etc. — is one of the Fed’s most common inflation-slowing techniques. The thinking is that rising interest rates will cause businesses and borrowers to spend less, tamping down inflation.

Since higher interest rates are generally used in response to inflation, they may take time to catch up to the rising inflation rates. In other words, you won’t see interest rates change overnight in the same way you might see overnight spikes in the price of gas or food. This means you should nab that good interest rate if you see it! Just make sure to choose a fixed rate (more on this below).

And the Fed’s adjustments aren’t always bad news for shoppers. When the economy is struggling, the Federal Reserve may lower interest rates to help stimulate the economy.

3) Higher Interest Rates Could Be a Good Thing for Buyers, Too

In short, inflation causes the Fed to raise interest rates, which could wind up costing you more money in interest if you choose to take out a car loan.

With that said, inflation isn’t the worst thing to happen to the automotive market. Higher rates may help balance the currently precarious market, making cars easier to get and, in turn, lowering purchase prices.

4) Does Inflation Make It Harder to Secure a Car Loan?

Yes and no. Here’s why…

New and used car prices are higher, which means more people will need to qualify for larger loans or provide a larger down payment. Additionally, if you lose your income or are unemployed, lenders are less likely to give you a loan because they want a stable payment history.

However, the market has improved the likelihood of getting approved for auto loan refinancing. Because of high used car prices, car values are higher and loan-to-value ratios have improved.

With more people looking to borrow money, lenders can be pickier than they were before. This means they may require better credit, a lower debt-to-income ratio, or a bigger down payment for the same rate. Additionally, with consumers struggling to make ends meet, they may find it risky to lend money to borrowers with a lower income or higher monthly bills. In theory, this could cause interest rates to spike.

With that said, for people who qualify, car loan interest rates are still generally on the decline. In fact, averages were at an all-time high of nearly 10% over 20 years ago, but they’ve remained steadily in the 4 to 5% range for about the last decade. This tells us that, while interest rates may be up by a few percentage points in the short-term, they’re still relatively low.

This is especially true if you’re a buyer with good credit, are willing to take a shorter loan term, or are looking for a good rate on car loan refinancing. It’s not uncommon to see well-qualified buyers and refinancers nabbing interest rates of around 2%. Things remain steady at the moment, but you should keep an eye on auto loan industry trends to make sure they don’t spike.

5) Does Inflation Affect Existing Loan Interest Rates?

And now for the million-dollar question: do spikes in inflation cause spikes in interest rates of loans you already have? That all depends on whether or not your loans have a variable or fixed interest rate.

interest rates

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Variable rates change based on the market, so they will likely rise if the Fed raises its benchmark, which it typically does during periods of inflation. On the other hand, fixed interest rates remain the same over the entirety of the loan terms, which means you won’t pay more during periods of inflation.

6) Should You Wait It Out?

While waiting things out may seem like the best thing to do if you need to buy a car at the moment, that’s not necessarily the case.

Indeed, higher car prices and rising inflation rates can cause consumers to pay more for auto loan financing. But rates have remained relatively low despite fluctuations in the economy over the last decade. On top of that, inflation may help cool off the currently high-priced automotive market, which could help lower the cost of buying a car.

Every borrower’s situation is different, so it’s impossible to say whether or not you will have trouble getting a loan. Speaking to a bank or lender is the best thing you can do to determine whether or not inflation has affected your chances of securing a car loan.



Jasper

Jasper has been an enthusiast of the automotive and IT industries since the age of 16. He independently writes on the auto industry's recent happenings.


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