How Does the Federal Reserve Impact Auto Loan Rates?
Does the Fed control your auto loan rates? The answer isn't a simple yes or no.
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The role of the Federal Reserve is to keep the United States economy on track. It works to monitor potential risks and adjust monetary policy to protect consumers and businesses alike. However, the tools it uses to do so have the potential to impact your auto loan rates.
Although the Fed does not directly dictate auto loan rates, it does have an implicit influence through the federal funds rate. When federal funds rates increase, it sets a benchmark for other lending institutions that could ultimately affect your car loan interest rates.
What Is the Federal Funds Rate?
The federal funds rate, sometimes referred to as the fed rate, is the interest rate at which Federal Reserve banks trade federal funds overnight. The federal funds rate is often used by the Fed to influence borrowing costs and gain control over wide-ranging economic conditions, such as inflation.
How the Federal Reserve Increases Interest Rates
The Federal Open Market Committee (FOMC) is a group of 12 policymakers with various financial backgrounds. It consists of the seven members of the Federal Reserve Board of Governors, the current president of the Federal Reserve Bank of New York, and four rotating presidents of the remaining 11 Fed banks from across the country.
This committee meets eight times a year to discuss the current state of the U.S. economy. They are responsible for making necessary changes to keep the market stable for consumers. In these meetings, the FOMC reviews economic and financial conditions, adjusts monetary policy, and evaluates any potential risks to their goals of price stability and sustainable economic growth.
Using forecasts provided by each policymaker that include metrics such as inflation and unemployment rates, the FOMC can help decide a federal funds rate that will promote optimal employment and fair pricing.
If the FOMC decides to adjust monetary policy, they may use their three tools — open-market operations, the discount rate, and reserve requirements — to make the necessary adjustments to keep inflation in check. Adjustments can influence the federal funds rate, which may then influence how lenders offer auto loan rates.
Are Car Loans Influenced by the Federal Funds Rate?
Although the Federal Reserve doesn't directly change auto loan rates, its influence on the federal funds rate produces a ripple effect that impacts interest rates across many sectors such as mortgages, credit cards, and auto loans.
When the federal fund rate changes, other economic conditions may adjust accordingly to account for the new fed rate, such as employment, the price of goods, and the prime rate, which is an interest rate used by banks as a reference point for most loans — including auto loans.
A lender's prime rate is not directly determined by the Fed. Many banks, however, base their prime rates on the federal funds rate, which could affect your car loan interest rates.
How Auto Loan Rates Shift with Federal Rate Hikes
Lenders are not required to change their prime rate in accordance with the federal rate hikes, but many will keep interest rates in line with potential risk. When the Fed raises its rate, it makes it more expensive for lenders to borrow money. If your lender decides to increase their rates alongside the federal rate, it could mean they're passing their higher costs onto you, regardless of how good your credit might be.
If the Fed chooses to increase rates, lenders can choose to raise their auto loan rates accordingly. This correlation means that keeping your eye on the current federal funds rates might help you get a better idea of how car loan rates could be affected.
