Will higher interest rates mean lower car prices?

Car market expected to shrink on double whammy of weak economy and soaring interest rates

The car market is shrinking as the year enters the final quarter and whicever way you look at the number, things are not rosy.

August sales as recorded by the Malaysian Automotive Association’s Total Industry Volume (TIV) shrank by 0.75% year-on-year to 47,227 units from 47,585 units previously. Year on year comparisons take away the seasonal variation factors but it sometimes fail to reflect the current dynamics and that is when you you compare numbers from month to month and here the picture is even gloomier.

August sales is 12.5 per cent paler than July’s numbers, the industry sold 6,757 units less during the Merdeka month.

The most obvious candidate for blame is the uncertain economic weather but it now has a friend, ballooning interest rates.

WHAT CAR COMPANIES CAN DO

Option I

SUBSIDISE INTEREST RATES

Car companies have been playing this game for along time, this is how you get zero per cent financing on a few per cent lower interest than the market rate.

Car companies know that people like to see that they are paying low interest and this is something that they play on.

By subsidising interest rates rather than reducing prices, they feel that it would help maintian the brand’s used car values on traders forecourts and this will make them more popular with usedcar dealers, crucial if you want to sustain strogn growth in the new car market.

Option II

SLASH PRICES

Car companies can play with their margin and decide how much they can cut so that customers do not have to suffer higher monthly payments as a result of higher interest rates.

While this may be good in the short run, it may have an adverse effect on the used car market so companies are typically reluctant to slash prices. Fromt heir persepctive, high interest rates are typically temporary market conditions whereas a brand’s strong used car value tookyears or maybe even decades to cultivate and if damaged will take as long again to repair.

So expect car companies to try and subsidise the interest rates for as long as they can, if high interest rates persist and it continues to have bearish effect on the market, they may reconsider their pricing policies. At the back of their mind, car companies are all hoping that customers will get accustomed to the high interest rates, much like how we got accustomed to higher petrol prices and will continue to buy their cars as usual again after a few months.

Option I vs Option II

Lets look at who wins and who loses when car companies chose between the two options and for ease of calculation we will use a car with a price tag of RM50,000 and compare interest of two per cent and new rates of four per cent.

OPTION I

Interest two per cent over five years

RM50,000 x 2% x 5years =RM5,000,

add that to the total car price and you pay RM55,000 total,

monthly payment = RM55,000/60 = RM916.66

Interest four per cent over five years

RM50,000 x 4% x 5 years = RM10,000

Total payment = RM60,000

Monthly payment = RM1,000 

To keep monthly payments the same car companies will have to subsidise interest rates back to 2%, in other words they will pay the finance company Rm5,000 every time someone buys this car so that the ttnerest rate is kept at 2%

OPTION II

Assuming that car companies can afford to slash prices by RM5,000 because that is what they are willing to pay to finance companies to keep their prices and customers monthly repayments we now look at the same scenario  but with the car price slashed to RM45,000 but interest rate is constant at 4%

Interest over 5 years

RM45,000 x 4% x 5 years =RM9,000

Total payment = RM54,000

Monthly installment =  RM900

Under Option II

WINNER: Customer

Because the monthly repayment is lower than even if the car companies subsidise the interest rate (see Option I where monthly payment is RM916.66).

PARITY: Carmaker

The carmaker is out of pocket RM5,000 either way, whether they give it to the bank or slash prices to attract customers but they do worry about used car value

LOSER: Bank

The total repayment amount is also less by RM1,000, which means that the bank actually makes RM1,000 less.

Under Option I

WINNER: Bank

They still make RM5,000 more from the deal because car companies are paying for extra interest payments.

PARITY: Carmaker

They still lose Rm5,000 every car but they feel better about not slashing prices

PARITY: Customer

He still pays the same monthly payments for the same car

r most people after houses.