Five Things to Know About Auto Loans

If you’re in the market for a new car, you know how perplexing purchasing or leasing a vehicle can be. With the increasing prices on vehicles and rising auto loan rates, there’s a lot to consider in making this important decision.

But these factors haven’t stopped consumers from making auto purchases. In fact, auto loan debt has climbed over the last decade. It now is the third-largest debt category after mortgages and student loans. In the first quarter of this year, auto loans increased by $10 billion, bringing the total up to $1.56 trillion.¹

Last month, the Philadelphia Fed hosted its Fifth Biennial Conference on Auto Lending to examine the continuing evolution of this key sector of the economy. The hybrid event brought together researchers, regulators, lenders, industry experts, and others to discuss the emerging risks and challenges and to learn more about the auto industry landscape more broadly. Overall, the data show that consumer sentiment is trending upward, with new vehicle sales and leases increasing, price inflation easing, and interest growing in the electric vehicle (EV) category. Here a few of the key takeaways:

The aftershocks of the pandemic are still working their way through the auto industry. The COVID-19 pandemic has had widespread, long-term effects on economic conditions, which includes the auto market. These effects include disrupted new vehicle production, a change in consumer spending and seasonal patterns, and an unprecedented rise of new and used vehicle prices. Service, repair, and replacement costs also continue to be higher, in part due to post-pandemic labor market tightness, which has impacted auto insurance costs.

Student loans could impact car loans. Consumers with student loans may need to restructure their budgets when the student loan forbearance ends in October. An estimated 40 million borrowers have not been required to make student loan payments since March 2020. And for many, this three-year payment pause has come with an added bonus: boosting their credit score. From 2021 to 2023, 43 percent of student loan borrowers increased their monthly payments on installment loans, including car loans. Yet data have shown that student loan borrowers have been repaying their credit card and auto loan balances at a slightly slower rate than all other consumers with credit card and auto loan debt. This is especially true of new loans taken out within the past year. When student loan payments resume — adding $245 on average or $160 as a median back into their monthly bills — it could further complicate their ability to meet their monthly debt obligations, particularly for borrowers who may not qualify for income-based repayment plans, loan forgiveness, or other loan deferment options.

Tread carefully before signing on the dotted line. The fine print can be costly. Research has revealed that some consumers are being overcharged for add-ons — products like Guaranteed Asset Protection (GAP) insurance, paint protection, service contracts, and extended warranties — that they did not consent to when they agreed to purchase the vehicle. In particular, the data show that Black and Latino consumers are consistently overcharged at higher rates than their counterparts. When making a sale, auto sellers are required to provide clearly written disclosures of all aspects of the vehicle purchase. Buyers have a right to review all costs and fees associated with the purchase — and ask for more clarity if needed — before consenting to the purchase.

Rethinking credit access could have employment benefits. Having reliable transportation to and from work is essential for maintaining a job. According to the Bureau of Transportation Statistics, 91 percent of workers use their personal vehicles to commute to work, at least some of the way. Many point to a vehicle as a tool for helping them to unlock more income opportunities, while 84 percent of respondents agreed that they have had to decline a job offer because they didn’t have access to their own vehicle, according to this Car Buying Outlook survey conducted in October 2021.

The reality is that owning or having access to a vehicle could increase economic mobility over time, particularly for workers who live in rural areas or the suburbs of more transit-rich urban cities. However, many low- and middle-income borrowers often face significant hurdles in financing a vehicle because they may lack credit history, often called credit invisible, or they may have a low credit score. But access to credit is a critical aspect of financial wellness and wealth building, including car financing, and some argue that increasing vehicle access is vital for reducing economic inequality. Today, credit underwriting, which is the process by which the lender decides who is creditworthy and should receive a loan, is gradually expanding to include nontraditional and alternative data, such as rent or utility payment history, address stability, or employment history. This shift in how borrowers are evaluated may create a more inclusive lending environment and allow lenders to offer credit to more young people, racial minorities, and consumers in low-income communities.

The future is electric. “With the right complementary policies in place, the auto industry is poised to accept the challenge of driving EV purchases to between 40 and 50 percent of new vehicle sales by the end of the decade,” according to Auto Innovators, an alliance representing the automotive industry. Auto Innovators point to a global investment of $1.2 trillion in electric vehicles (EV) by 2030 and rapidly expanding battery manufacturing capacity by 2035. Across the U.S., a number of states have set their own targets for reducing carbon emissions, allocating both resources and investments to building infrastructure, and bolstering purchasing incentives. California, New Jersey, Rhode Island, and others have set statewide goals to fully transition to all EV sales within the next 10 to 12 years. EV makes and models continue to grow with light truck sales (utility vehicles, pickups, and minivans) making up almost three-quarters of all EV sales in the first quarter of 2023.

The full conference agenda and materials can be viewed and downloaded here. This event was cohosted by the Federal Reserve Bank of Philadelphia’s Supervisory Research Forum (SURF) and Consumer Finance Institute (CFI).

Emerlee Simons, a 2023 intern at the Philadelphia Fed, contributed to this article.