As 2024 shifts into gear, prospective car buyers are being confronted with a complicated road when it comes to financing their next set of wheels. A conflux of economic headwinds and tailwinds are creating a delicate balancing act for both lenders and consumers navigating the auto loan market.

On one hand, stubbornly high inflation rates show few signs of letting up, with the latest data putting the Consumer Price Index at an elevated 5.6% over the past year. The Federal Reserve’s aggressive interest rate hikes aimed at pumping the brakes on surging prices have sent borrowing costs soaring across all major lending sectors. This has significant ramifications for car shoppers, both for financing new purchases as well as consumers looking to refinance existing loans.

Data from Edmunds indicates that the average annual percentage rate (APR) on new financed vehicles reached a staggering 6.9% in the fourth quarter of 2023 – a level not seen since the financial crisis of 2008-2009. Rates on used vehicles paint an even starker picture, with the average used APR hitting 10.6% to close out last year.

“Purchasing a vehicle has become an increasingly expensive proposition in this rising rate environment,” says Jessica Caldwell, executive director of insights at Edmunds. “Consumers who could previously stretch loan payments out over longer terms to keep monthly costs manageable are now getting pinched from both ends – higher interest charges and elevated sticker prices.”

Indeed, the combination of escalating finance charges and still-elevated vehicle prices has led to some worrying affordability issues. The average monthly payment for new vehicles topped $760 in late 2023, while used car buyers were shelling out over $575 per month. With the typical car loan extending past the 70-month mark these days, the total interest costs over the lifetime of these loans are edging into five-figure territory.

This dynamic is already pricing many Americans out of the new car market entirely. Sales of new vehicles were down around 8% year-over-year in 2023 as buyers stayed on the sidelines. Analysts at Cox Automotive forecast that new sales could take another step back in 2024 if rate and affordability pressures persist.

“Depressed consumer demand is going to put automakers and dealers in a real bind, forcing their hands on incentives and discounts,” says Charlie Chesbrough, senior economist at Cox Automotive. “We’re already seeing the industry hike incentive spend to counter still-high sticker prices and interest rates.”

The used car market, however, could benefit from a rotation of priced-out buyers seeking more budget-friendly options – a pattern playing out in late 2023 as used sales ticked slightly higher while new sales slumped. That said, elevated interest rates on used loans are their own obstacle in enabling these more affordable transactions.

Beyond pure affordability questions, broader economic uncertainty is also poised to be a factor impacting auto lending in 2024. While the job market remains relatively sturdy for now, recession fears could prompt many Americans to postpone big-ticket purchases like cars until conditions show signs of stabilizing.

Credit scoring models used by major auto lenders are also being recalibrated, with a growing focus on minimizing risks stemming from excessive household debt burdens, limited savings, and other signs of financial strain. This dynamic contributed to a slight downtick in average credit scores on auto loans in late 2023, according to data from Experian.

“Auto lenders are proactively tightening credit standards to get ahead of potential asset quality issues,” said Melinda Zabritski, senior director of automotive credit at Experian. “In a slowing economy, managing losses is top of mind – especially in subprime tiers that tend to experience higher delinquencies during times of stress.”

While rising interest rates have pressured affordability across the board in 2023, some prospective borrowers may still find relative respite in the longer loan terms increasingly offered by lenders. Loans stretching out 84 months or longer now account for over 40% of new vehicle financing, in a bid by lenders to shore up demand by lowering monthly payment costs.

Of course, these extended terms come with their own risks – namely, keeping borrowers underwater on their loans for longer periods of time. Average negative equity per vehicle still hovers around $5,000 due to accelerated vehicle depreciation.

Still, many buyers appear willing to stomach the drawbacks if easier monthly payments are the tradeoff. “Realistically, our budgets only go so far, so longer loans that reduce the upfront monthly burden are going to remain popular choices for keeping vehicle costs manageable,” said Mike Buckingham, senior managing director at Clayton Financial.

With economic uncertainty swirling, some buyers may understandably be inclined to tap the brakes on new vehicle purchases in 2024. However, for those still determined to get behind the wheel, securing financing will likely grow only more challenging as affordability constraints intensify.

Lenders continue walking a tightrope, looking to extend credit wherever feasible while also guarding against excessive risk exposure should the economy take a further downturn. Prudent underwriting and realistic consumer expectations are set to be paramount in navigating what lies ahead for the auto finance industry in 2024.

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