I’m going to start and end this blog post with a question: Why are there no adjustable-rate auto loans? Is the idea that ridiculous? (Ok, I’ll start it with two questions.)
Car loan terms have increased significantly during the past 40 years. When the Federal Reserve started tracking auto loan terms in 1971, the average maturity was 35 months. Since then, the average car loan has stretched to 62 months, according to the Federal Reserve. Five years is a long time. It’s the equivalent of a complete economic cycle.
One of the primary benefits of adjustable-rate loans is that they offer a natural interest-rate hedge for the lender. If interest rates move too far one way or the other, borrowers may be more likely to walk away from a loan, especially if they can get a better deal.
Interest rates serve several purposes. They act as a risk-management tool for borrowers who are more likely to default. They also act to cover the cost a lender incurs to borrow the money that gets lent out for the car loan. They also act as a profit margin. There is also a risk for most financial institutions, which fund loans from deposits made by consumers. Deposit interest rates fluctuate based on the credit and capital markets. Banks run the risk of losing money by offering too many fixed-rate car loans at a certain rate, only to see the rate they need to pay to gain deposits increase.
By introducing an adjustable-rate car loan, lenders would be able to price their products more competitively, without worrying how interest rates are going to move in the future.
Credit card rates fluctuate. Mortgage interest rates fluctuate. Yes, auto loans are a different asset class. But are they so different that the interest rate on the loans used to purchase automobiles can’t fluctuate, too?
