Economic Indicators

Subprime Auto Loans Face Higher Interest Rates Amid Inflation Fight


© Pavlo Gonchar / SOPA Images/Sipa via Reuters Connect

 

The Federal Reserve’s efforts to combat inflation have led to higher interest rates on new auto loans for subprime borrowers this year, according to a report by Fitch Ratings on Thursday. The annual percentage rate (APR) on these loans has increased from 14% last year to a range of 17% to 22% this year. This rise in APR is significantly impacting lower-income households, increasing their monthly auto payments and consequently raising the risk of late payments, defaults, and car repossessions.

Despite these risks, data from Finsight reveals that the subprime auto sector has cleared nearly $30 billion in new bond deals this year. Although this figure is slightly below the volumes from the past two years, it remains above historical levels since 2008.

Tracy Chen from Brandywine Global Asset Management warns that if these high rates persist, they could trigger an economic downturn. This sentiment aligns with widespread anticipation of a recession.

In response to the steady yearly inflation rate of 3.7%, the Federal Reserve has raised its policy rate to a 22-year high of 5.25% to 5.5%. Gregory Daco, EY Chief Economist, suggests that the focus now is on how long these rates can be maintained rather than how high they might go.

The Dow Jones Industrial Average (DJIA) and S&P 500 (SPX) indexes showed little change following the release of the inflation report. Despite potential higher defaults among borrowers, there hasn’t been a significant increase in the spread on subprime auto bonds. An AAA-rated 2-year slice bond deal saw a spread increase from 90 basis points to 115 above the relevant risk-free rate.

Delinquencies in subprime auto loans rose to about 5% in September, as per Intex data, but are still not at crisis levels seen in 2008. Factors such as Treasury rates and Wall Street bond bids also play a role in this scenario. Despite the rising rates, longer-duration bond yields remain below 5%.

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