CARS.COM — As the Federal Reserve raises interest rates for the first time in nearly a decade this week, what does it mean for car shoppers? Experts say the immediate effects will be slight, but future rate hikes will likely raise the rates on your next car loan, down the road.
Related: What You Need to Get a Car Loan
What car shoppers should know:
How much will the rate hike increase interest rates on car loans right now?
Not much, experts say. The Fed's rate increase was just 25 basis points, or 0.25 percent. That's small, and it's important to realize that interest rates are still low. The Fed rate is short for the federal funds rate, the interest rate that banks can charge to loan money held at the Federal Reserve to other banks. A rise in the funds rate generally causes other interest rates to rise, though not necessarily at the same time or by the same percentage.
Melinda Zabritski, Experian's senior director of automotive finance, notes that the increase, though small, will affect interest rates on auto loans, but the impact will be "very, very little," said Nariman Behravesh, chief economist at IHS, a consulting firm. "We're just talking about 25 basis points," Behravesh told Cars.com.
Why such little effect?
Experian places the average interest rate on a new-car loan in the third quarter of 2015 at 4.63 percent. That's up versus 4.47 percent in 2014's third quarter. Interest rates on used-car loans have increased similarly.
Mike Buckingham, a senior director at J.D. Power and Associates' auto finance practice, notes that rates have risen over the past 60 days. What's more, the Fed's benchmark rate isn't the only factor that lenders use to determine your interest rate on your car loan.
Buckingham said banks determine interest rates based on how much cash they have on hand, as well as their assessment of market conditions.
"I don't want to say the Fed funds [rate] is irrelevant," he said, but "it's not as if tomorrow, wow, rates will go up."
So where are interest rates going?
This week's rate hike signals the likelihood of future rate hikes, which would likely push interest rates higher on future car loans. CNBC reports that most members of the Federal Open Market Committee, the body that sets the Federal Reserve's interest rate, expect rates to be at 1.5 percent or lower by the end of 2016, climbing to the low-3-percent range by 2018.
Won't competition between lenders keep interest rates low?
It should have some dampening effect. Zabritski expects increased competitive pressure and a higher emphasis on subsidized interest rates from automakers' finance companies to keep rates down.
Lenders have seen "some incremental price increases in there, but they want to be competitive in the marketplace," Buckingham said. "I think everyone looks over their shoulder and sees who's going to make the first jump [in loan rates], if any."
If and when rates increase, who will be affected more: shoppers with bad credit, or those with great credit?
It's hard to say. Buckingham said auto-loan rates will "absolutely" go up over the long term, but not any more so among lower-credit shoppers than those with good credit scores.
Zabritski said the Fed's rate increase would drive "likely a stronger impact" for interest rates among lower-credit shoppers. Behravesh expects that, too, but he said the difference won't be much.
"People who have lower credit ratings will see obviously bigger hikes as a result of what the Fed is doing than people with good credit ratings," Behravesh said, but "it's still going to be relatively modest increase, even in [loans for] the least-qualified borrowers."
Should I buy a car now?
Consumers shouldn't rush to buy their next car on account of this week's news, Behravesh said, but it wouldn't hurt for anyone already in the market to take advantage of today's still-low rates.
"If they've got the finances, and they think that sometime in the next year they would like to buy a car, [there's] no harm in doing it earlier rather than later," he said. "But this is not a strong recommendation."
Whenever interest rates go up — whether it's now or later — how much will that affect my monthly car payment?
Less than you may think. Interest rates don't affect car loans as much as they do, say, home mortgages. A five-year, $25,000 new-car loan at 4.0 percent interest is $460 a month, but if your rate climbs to 4.5 percent, that payment increases just $6, or about 1 percent. Compare that to a 30-year, $300,000 mortgage at 4.0 percent, which leaves you a monthly mortgage payment of $1,432. If you raise the rate to 4.5 percent, it adds $88, or about 6 percent, to your mortgage payment.
Auto loans mask the effect of interest rates because they're short, compared to mortgages. They're also quite flexible in terms of loan length. Lenders (and consumers) can always reduce the sting of a higher interest rate — or a pricier car, for that matter — by extending the loan terms, though it isn't necessarily a good idea.
That's already going on. In the third quarter, some 44 percent of new-car loans were 61 to 72 months long, while another 27.5 percent were 73 to 84 months — both record Q3 highs, according to Experian.
"What matters even more than the [interest] rate itself is what the monthly payments are," Behravesh said. Lenders will exercise "a lot of flexibility" to keep monthly payments low, even in a higher-rate environment, he added.
Will the rate hikes affect leasing availability and rates?
Maybe, if all other things were equal. Zabritski said there "could be an impact" if consumers trade in their leases early to lock in lower rates prior to the expected hikes. But future leases are impacted by other market factors, like residual values, she added.
Automaker intervention affects those rates, too. Buckingham notes that although interest rates affect lease terms, automakers subsidize those rates so much that the actual increase shoppers would see is a mystery.
"To the manufacturers, their cost of leasing will rise slightly via the interest rate," he said. "What is unknown [is] will they pass it onto the consumer."
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