Interest Rates and Automobile Sales

The automobile industry sales have been stagnant for the past couple of years. However, this is bad news. This is because almost all industries in the world have seen an extended bull run. The world has seen some of the lowest financing costs in history over the past decade or so. Hence, it can be said that if the sales are stagnant even with easy financing, they might suffer a lot when interest rates once again start going high. This is because automobile sales are extremely sensitive to interest rate hikes. In this article, we will have a look at how changes in interest rates affect car sales.

However, before that, we will have a look at some of the demographic factors which are responsible for the stagnation in car sales despite the availability of easy financing.

Demographic Reasons behind Declining Sales

The main reasons provided for this stagnation are demographic.

  • More millennials are living in big cities. This means that they are using public transportation or Uber to go wherever they want. As a result, they are not buying as many cars
  • Also, millennials are postponing their marriage decision. As a result, the ones that are living in the rural areas aren’t buying big expensive cars either. They are content with smaller cars since their family size is small
  • Also, the baby boomer generation is on the verge of retirement. As a result, they need to save money to take care of themselves in old age. Hence, they do not have the disposable income to buy as many cars either
  • Also, surveys conducted have shown that the income of the average American worker has been stagnant for close to 20 years now. This means that most Americans simply do not have the funds to buy newer automobiles

Hence, automobile sales have remained stagnant over many years now. However, if we take into account the fact that the population has increased quite a bit during these years, we come to the conclusion that the per capita automobile sales are actually declining. This obviously is not good news for the car industry. These companies are themselves laden with debt and need to at least maintain sales in order to survive. The fragility of these companies became apparent during the 2008 meltdown when General Motors was forced to take a government bailout.

The problem is that even the present level of sales has been achieved with the aid of loose financing and low-interest rates. Now, that the Fed plans to increase interest rates, the cost of borrowing to own a car may go up. This is likely to unleash mayhem in the automobile industry.

Easy Financing of Cars

Automobile dealers have been upselling more expensive vehicles to clients with the help of lower interest rates. Their sales tactics revolve around showing the user why buying a bigger car only costs slightly more per month. This is because automobile loans have been made available at very low interest rates. Had these interest rates not been slashed during the 2008 crisis, the automobile industry would have suffered greatly back then.

In the recent years, automobile companies have been struggling to keep up their sales. As a result, they have once again started loaning out money to subprime borrowers at high-interest rates. The problem with this strategy is that it allows for a temporary boost in sales. However, over the long run, it leads to missed payments and repossessions. Right now, companies are able to securitize their auto debt and sell into third parties, thereby freeing themselves from any obligations. However, this might not continue for very long since the interest rates are now facing an upward trend.

The Double Whammy for Automobile Industry

The automobile industry is extremely sensitive towards interest rate hikes. This is because the industry already has a large amount of debt. An increase in the interest rates makes servicing this debt even more expensive. Hence the costs increase and the company requires more sales in order to remain profitable. However, as we have seen from this article, rising interest rates end up depressing the sale of automobiles as well. These companies, therefore, face a double whammy wherein their costs go up, and sales go down.

To sum it up, the American consumer is already saddled up with a lot of debt. They have student loans, mortgages, credit card bills, etc. Since the rise in income is not living up to the expectations, some of these people are resorting to reducing their spending. Cutting up in auto debt is one of the biggest ways to achieve this goal. As a result, it is likely that the sales of automobile companies may be in doldrums in the forthcoming years since interest rates are expected to keep on rising from hereon.

❮   Previous  Article Next  Article   ❯

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.


Corporate Finance