What happens in 2016 if interest rates rise?

NEW ORLEANS -- 2014 will be a good year for the industry. But what about 2016?

The following draws from speeches at the American Financial Services Association conference, which precedes the National Automobile Dealers Association convention here.

Imagine Mae. In March 2013, she traded in a six-year-old car for a three-year-old one. By mid-2016, she's looking to replace it. She's back to working full-time, finally, and might consider buying new this time.

But when she goes online, she sees that new-car prices have risen more than she expected. And when she goes to the dealership, she finds that her current car isn't worth as much as what she got for her trade-in in 2013. Plus, interest rates have risen to 5 percent for a car loan, from the 2.5 percent she had been paying.

What happens next? Here are some scenarios and options.

  • If Mae is 62, she remembers car loans at 17 percent, so a 5 percent rate is nothing. But if she's 26, she's doing a double-take at that rate, especially since her student loan rate also has risen.
  • To keep her monthly payment low, the F&I manager suggests a 96-month loan -- on a three-year-old car. Both the F&I manager and Mae know she'll be underwater when she next goes shopping for a replacement car, unless she plans on driving an 11-year-old car. But there are plenty of lenders eager for the business, so the deal goes through.
  • To get Mae back in the market sooner, the saleswoman suggests a subvented five-year lease on a CPO car. The lender, an automaker's captive, convinces itself that the most optimistic projected residual values will come true, and approves the deal.
  • Mae knows she can't risk falling behind on the payments and having her car repossessed. So she scales back, buying a four-year-old car with fewer features than she had planned.
  • Or she waits until 2017, and then buys a four-year-old car.

Which of these scenarios are best for the dealer? For the automaker?

And, most importantly, which of these 2016 scenarios could be improved if dealers, lenders and automakers start adjusting their policies in 2014 in anticipation of the interest-rate increases most forecasters predict will come sometime in 2015?

You can reach James B. Treece at jtreece@crain.com

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