Over the past few years, automotive retail lenders have been navigating a turbulent landscape, facing challenges like the COVID-19 pandemic, supply chain interruptions and escalating vehicle prices. Although inventory levels are recovering, consumer hesitation lingers, with the average vehicle price still hovering around $50K.

But a potential market shift may be on the horizon, sparked by the Federal Reserve's recent interest rate cuts. In November, the Fed reduced interest rates by 25 basis points, following a similar cut in September. Although borrowing costs remain high, these changes could stimulate car buying, presenting both opportunities and challenges for auto lenders.

The Fed's Influence on Auto Financing and the Expected Consumer Response

Historically, interest rate changes have impacted vehicle affordability and sales. Following the recent rate cuts, experts anticipate lower borrowing costs, reduced monthly payments and increased consumer confidence.

For lenders, this means heightened competition in financing. Competition will be especially fierce for buyers with excellent credit who may have delayed buying a new car due to high prices. These shoppers are primed to jump back into the market because of lower interest rates and their ability to qualify for most loans.

Capturing this segment will be crucial as the total number of loans is expected to stay flat through the end of the year.

Lenders Must Navigate Competitive Pressures

While these changes are expected to boost consumer confidence and borrowing power, they also introduce new challenges for lenders, particularly in terms of heightened competition and pressure on profit margins.

With the cuts we've seen, it will be less expensive for lenders to extend credit to customers, and costs should decrease for the end consumer. But this leads to another challenge: adapting to changing rates and competitive pressures.

Lenders most likely will respond to the rate cut by lowering their own interest rates, which could narrow their gap with the federal-set prime rate. Lenders that have the smallest margin stand to win the most business, but they risk cutting into their profits.

Lower rates could help decrease inventory levels, much to the relief of dealers. But if inventory remains high, OEMs and captive lenders face additional pressure to offer subvened incentives, further cutting into their bottom lines.

Still, lower rates along with OEM and captive lender subvened incentives can attract customers in a competitive marketplace.

Leasing Could Be a Key Opportunity

While competition intensifies in loan offerings, lenders may find leasing to be a more profitable and sales-advantageous avenue to explore. Captive lenders in particular could benefit, as they offer more lease options than non-captive lenders.

Leasing also fosters stronger customer loyalty than loans, because lessees must go back to the dealership at the end of the lease term.

We've already seen a rise in leasing in 2024 driven by incentives and customer loyalty. Lenders should focus on developing attractive leasing options, especially for electric vehicles (EVs) and hybrids, to capitalize on these changing consumer preferences.

The Inflation Reduction Act and Potential Impact

In addition to adjusting to market changes, lenders must also be mindful of external factors such as government policy. For example, the Inflation Reduction Act (IRA) introduced a range of incentives aimed at boosting EV adoption, including consumer tax credits for qualifying EVs. However, the new administration may change this legislation, which could affect EV sales and, in turn, auto financing.

If the IRA is reversed or amended, the loss of EV tax credits could dampen consumer demand for these vehicles. This change could have ripple effects on both manufacturers and lenders who have invested in promoting EVs through financing and leasing options. This uncertainty requires lenders to stay agile and responsive to potential shifts in consumer behavior and government policy.

Lenders Need Visibility in a Changing Industry

Visibility into the competitive landscape opens doors by allowing lenders to make more informed decisions and adjust their offerings. Visibility also helps lenders manage diverse, increasing and highly complex incentives and communicate transparently to drive informed consumer decisions, even in challenging markets.

Key Tools for Analyzing Competitive Positioning

Lenders today have two critical tools from S&P Global Mobility at their disposal, allowing them to analyze their competitive positioning and adjust their strategies accordingly.

AutoCreditInsight - offered in partnership with TransUnion - provides actionable observations for clients including competitive lender credit attributes based on New and Used vehicle registrations received after month-end.

Additionally, Market Scan software provides real-time market analysis that lets lenders track what their competitors are offering down to the ZIP code and trim level.

Using Data to Drive Market Strategy

With this visibility, lenders can analyze their position in the market, simulate changes to their offerings to see where they could stand, and take action based on the data.

Lenders can also use this data to attract customers. Lenders that provide a wide range of purchasing and leasing options will be able to offer their customers deals that best suit their budgets and lifestyles. Additionally, lenders that provide accurate, transparent pricing — accounting for all incentives, taxes and fees — at every stage, from online advertising to the final transaction, will gain the most customer loyalty.

By leveraging real-time data and staying responsive to both market and policy shifts, lenders can not only remain competitive but also cultivate long-term customer loyalty.

Learn more about AutoCreditInsight

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This article was published by S&P Global Mobility and not by S&P Global Ratings, which is a separately managed division of S&P Global.