Subprime Buyers Get Squeezed Out of Auto Market by Fed Rate Increases

As our team has noted consistently this year, the economy’s fundamental issues revolve around inflation and the high-and-increasing interest rates being applied to stop inflation.  

Yesterday, the Fed moved rates higher again for the 10^th time in a row. If there is a silver lining for consumers here, it is that the Fed is likely ready to take a pause in rate hikes. As our Chief Economist Jonathan Smoke noted in commentary posted after the May Fed meeting, “further increases are now less likely than not.”  

As expected, auto loan rates have followed the Fed’s course, rising consistently in 2022 and 2023. At the end of Q1, the average new rate was almost 9%, while the average used rate stood near 14%. While the higher rates are holding down used-vehicle sales – along with tight inventory – the new-vehicle market has outperformed expectations so far in 2023. Year-to-date sales are showing modest strength, at least compared to 2022, and the new-vehicle sales pace in April was approaching 15.9 million, a sizable increase from April 2022.

Underneath the topline numbers, however, is the reality that the Fed’s actions, along with the new-vehicle inventory shortage of 2022, have reshaped the new-vehicle market in the U.S. “The rate increases we have seen have limited who can buy vehicles,” Smoke notes.   

High auto loan rates have drastically reduced the number of subprime and deep subprime shoppers closing deals each month in the new-vehicle market. In turn, as fewer low-credit-score buyers enter the market, the automakers continue to tilt their product portfolios to more profitable, higher-revenue products targeting who’s left: High income, high-credit-score buyers.  

In 2018, subprime buyers routinely made up more than 14% of new-vehicle sales, while deep subprime buyers were close to 10% of the market. That began shifting in 2019, and in the spring of 2020, when the pandemic hit with full force. Buyers with lower credit scores began to fall out of the market. This year, with rates peaking, subprime buyers account for roughly 6% of new-vehicle sales; deep subprime is less than 2%. 

Subprime and Deep Subprime Share of New-Vehicle Market

 
Consider this back-of-the-napkin comparo: The average new-vehicle transaction price in March was approximately $48,000, according to Kelley Blue Book. For a top-credit-tier buyer, the typical loan, with 10% down and a 72-month term, could be secured at a rate of approximately 6.2% and would saddle a top-credit score buyer with a monthly payment of $720.  

The same vehicle, same loan, would be a very different story for a shopper with a subprime credit score (below 620). With a typical subprime auto loan rate of 17.9%, the monthly payments on the $43,200 loan ($48K minus 10%) would jump to $983 a month. 

That is a world of difference, but only part of the story. Importantly, over the 72-month term of the loan, the high-score buyer would spend a total of roughly $52,000 to pay off the loan, covering $8,700 in interest payments. A subprime buyer, conversely, would need to shell out more than $27,000 in interest payments, pushing the total loan cost to $70,000.   

While the headlines showcase new-vehicle sales improving as inventory increases, the rebounding U.S. auto market is now a very different market than it was five years ago. And the average new-vehicle buyer is very different as well.