What a recession means for your car loan interest rate

Talk of a recession is never good news, and people often think about how it will affect their jobs and finances. However, when it comes to your car, a recession can also have a big impact. From increasing interest rates in a pre-recessionary period, to decreased spending power and potential auto part shortages as the recession hits, an economic slowdown can negatively impact your financial situation, vehicle equity, and viability of your car loan. Here is what you need to know about when it comes to your car and economic downturns.

What is a recession?

A recession is when an economy shrinks for at least 6 months. Recessions can be caused by lots of different factors, but when a recession is triggered, it’s normally not good news for the majority of households. It is triggered by at least two successive fiscal quarters where an economy shrinks with lowered gross domestic product, or GDP. A recession can mean loss of working hours or unemployment for some people and tightening budgets for many more. Because of concerns about the health of the economy and the future of people’s livelihoods, many households choose to spend less money and save more.

This can lead to a decrease in profits for both corporations and small businesses, and more potential job losses and business cutbacks and/or closures. While recessions are signs of a naturally expanding and contracting economy, failure to plan for them often leads to increased stress and strain on your family’s expenses. If a recession continues for long enough, it can turn into a depression which is the next worst phase in a downward trending economy that can potentially last for several years.

How is a recession different from a depression? 

You may have seen comparisons between a recession and depression as well. However, they are not the same. A recession differs from a depression in a few ways. Recessions are normally triggered after two quarters of negative GDP growth, and can represent a temporary slowdown in economic activity. Depressions, on the other hand, are much more serious with significant impacts to economic growth, employment, and the production of goods and services. 

A full-fledged depression can result in layoffs and unemployment increases in many sectors of the economy. Unlike a recession which usually lasts for less than a year, depressions are sustained periods of economic strife which can leave many people in a precarious financial situation. During a depression, economies experience substantial slowdowns in production, cutbacks on spending, and prolonged periods of economic shrinkage.

An economy can enter into a depression if a shorter term recession leads to years of declining economic activity without a positive upturn. The differences between the two aren’t always exactly clear, so the best way to gauge a continued progression is by looking at the duration of the situation and the overall impact and consumer sentiment.

Recessions and interest rates

When the signs of a recession are emerging, governments and central banks will often take steps to try and fix things before they get too bad. Governments might implement economic policies that can restart economic growth, or policymakers might choose to change interest rates to keep the economy afloat.

Interest rates usually increase before a recession takes place. These hikes are usually done for a few reasons, including to help to ease inflation and decrease consumer spending. This practice helps to balance consumer spending habits if market demand is greater than the available supply of goods and services.

During a recession, interest rates typically decrease. This is because policymakers want to encourage people to spend more instead of saving. However, as previously mentioned, interest rates often increase before a recession to combat inflation. In the case where inflation and prices are steadily rising across the country, policymakers will sometimes have to raise interest rates before a recession occurs or possibly even early on during a recession to keep prices lower, just as we discussed in why interest rates change.

Car loan interest rates

So what does this mean for you? Well, it can mean a few things if you’re looking to take out a car loan and a recession is looming on the horizon. If interest rates increase, you can also expect your car loan repayments to come with higher interest repayments too. For this reason, if you’re looking to take out a car loan ahead of or during the early stages of a recession, be aware and plan ahead with your car budget. It may be harder to take out an affordable car loan during a recession.

However, there’s always a way you can get a car loan. Even if interest rates are adjusted or hiked multiple times, it can still take some time for the ripple effect to be registered and passed down to you through lenders. For example, if the Federal Reserve were to raise the base federal funds rate tomorrow, it may take a few days or even weeks before you are impacted as you try to qualify for a car loan or refinance your current loan.

The longer you wait before a recession, you may see increasing interest rates associated with the loan.  Moving quickly and early can be a good option when it comes to handling loans and recessions.

Vehicle equity and the value of your car

Recessions may also impact the value of your car along with your auto loan’s interest. Because households need to start tightening their budgets, many people will be more reluctant to spend money on cars that will cost more to buy, drive, and maintain. After all, spending more money on a car along with increased expenses due to things like the rising cost of gas or paying more for an expensive insurance policy because your car is newer isn’t that great of an idea when you can afford less.

Selling your vehicle can be more difficult during a recession. Between more expensive loan options, less disposable income, and reduced car buying demand, selling a car to get your money out of it can be tricky. Some dealerships may slash prices on new cars to move vehicles and generate buying interest. The lower asking prices also impact the values of trade-ins and used vehicles since the dealers have a smaller profit margin.

Auto part supply problems

The production of goods usually decreases during an economic downturn and there can be shortages in the supply of car parts during a recession. As mentioned already, recessions don’t always have a major impact on all sectors of the economy, but they can more easily affect import and manufacturing companies. This is because they often move products internationally, source components from multiple countries, and deal with currency fluctuations.

If a recession takes a particularly tough toll on the manufacturing sector, you may find that auto part supplies are restricted due to things like reduced demand, raw goods shortages, cash flow problems, and staff reductions. These roadblocks can mean that finding the right parts to repair your car can be harder to come by.

Auto part shortages can affect both new and used vehicles. From electrical chips and electronic control units, or ECUs, down to simpler components, shortages can mean fewer new cars are produced and brought to market. For used cars, the shortages can send auto repair shops scrambling to find other sources of parts from aftermarket suppliers.

If your budget is a little tighter, using aftermarket components could be a good cost-effective way to maintain your vehicle going forward during an economic downturn.

Planning for a recession

It’s very hard to know when a recession will occur, but it is a good idea to plan ahead. There are a few simple things you can do to get ready. First of all, it’s always a good idea to start limiting your expenses and have a budget to monitor your expenses. To find out more about reducing and limiting your car expenses, see our guide on reducing vehicle expenses.

Being prepared

Recessions can cause problems for many households. But, with the right preparation, a recession doesn’t need to make maintaining your car or making your car payments difficult. As they say, “Hope for the best, but have a plan for the worst.” We can work together to get through these hard times and make your finances better and more stable in the process. At Caribou, we’ve been saving drivers time and money when it comes to finding the right refinancing option. Find out more about how refinancing works.

Our content is intended to be used for general information purposes only. It is very important to do your own analysis before making any investment based on your own personal circumstances and consult with your own investment, financial, tax and legal advisers.

Car loan recession FAQs

• What is a recession? A recession is when an economy shrinks for at least 6 months. Recessions can be caused by lots of different factors. This can lead to a decrease in profits for both corporations and small businesses, and more potential job losses and business cutbacks and/or closures.

• How is a recession different from a depression? A recession differs from a depression in a few ways. For example, recessions are normally triggered after two quarters of negative GDP growth, and can represent a temporary slowdown in economic activity. Depressions, on the other hand, are much more serious with longer term impact on economic growth, employment, and the production of goods and services.

• How does a recession impact interest rates? Interest rates usually increase before a recession takes place. These hikes are usually done for a few reasons, including to help to ease inflation and decrease consumer spending. During a recession, interest rates typically decrease. This is because policymakers want to encourage people to spend more instead of saving.

• Can I refinance my car during a recession? Yes, you can still refinance your car. Changes to interest rates can take some time to be registered and passed down to you through lenders. Moving quickly and early can be a good option when it comes to handling loans and recessions.

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