Interest rates for new car loans have been on the rise. In fact, according to Edmunds, they reached their highest mark in the past eight years during the first quarter of 2018. As interest rates rise, the average dealership gets dealt two heavy blows. One, it means there are less buyers available who can afford new cars, and it also means that dealers have to deal with the cost of holding on to excess inventory.

Right now there is a combination of forces squeezing buyers that could cause car sales to slip. Sales seem to have already peeked for 2018. Prices are also increasing. According to Kelly Blue Book, new car prices rose on average nearly 4% in January 2018. Add to that the increase in interest rates and transaction fees, plus increasing fuel costs also impacting consumers’ pocketbooks, and you have far fewer buyers currently able to purchase a new car.

So far, new vehicle sales have been incredibly resilient and have withstood continued increase in prices and the slow rise in interest rates. However, the combination of a rise in vehicle prices, coupled with the rise in interest rates, will lead to a tougher sales environment for auto dealerships heading into the last quarter of 2018 and into 2019.

A decline in sales can lead to higher than desired inventory levels, with the dealership having to absorb the cost of carrying the increased inventory, despite floor plan assistance rates. This is particularly true of certain models that have more options, which increase the cost of the vehicle.

Controlling Inventory

Controlling new inventory levels to less than 90-days supply, and used vehicles to less than 60-days supply, is a good rule of thumb, but a better way to make it abundantly clear just how much floor plan interest expense can eat into dealership profitability, is to calculate the holding cost past the point that the floor plan assistance covers your inventory carrying costs.

So, for example, on a new unit of $40,000 that is floored with your floor plan lender at an interest rate of 5% and the manufacturer provides floor plan assistance for 90 days, every day past the 90 days is an expense, and every day that it’s under 90 days, the floor plan interest turns into a floor plan interest profit for the dealership. So, if a dealer can sell a new unit 30 days after it hits the showroom, the dealership earns 60-days worth of floor plan assistance or about $329 on that unit. If, on the other hand, the unit sells 30 days after the 90 day period, that unit is costing the dealership $164. If on average, the dealership sells 50% of its new inventory units at 120 days (and assuming the same $40,000 cost), and sells an average of 150 units a month, that’s approximately $148,000 a year in additional floor plan costs that come right out of the bottom line.

What Dealers Should Be Doing Now

So, what can you do to control floor plan costs in a period of rising interest rates?

  1. Manage the inventory mix on a daily basis. On used vehicles that are floored, this is particularly important.
  2. Identify slow-moving units every week and price them accordingly, taking a loss or less profit today will almost always be better than taking both a loss later and having to incur additional floor plan costs.
  3. Show your oldest vehicles in a “specials” section of your website and promote them with social media and other marketing strategies.
  4. For very old units, keep your new and used car managers accountable. A monthly write-down on units aged more than 90 days will keep sales managers more accountable. Another way to keep the sales managers accountable is to incorporate inventory aging levels as part of the sales manager pay plans.
  5. Be aware of the additional impacts that can occur should the proposed 25% tariffs on imported vehicles and parts be imposed. You can see a detailed analysis of what these may be, and how to prepare for them, in our companion article, How Will the Trump Tariffs Impact the Auto Industry?

It is not all bad news for auto dealers. The Wall Street Journal reports that the average credit score for borrowers buying and leasing new cars, is at its highest since 2015. Which means that the rising interest rates will mostly impact subprime borrowers.

These changes in disposable income and available credit, could also mean that car buyers may be more interested in used and certified pre-owned inventory. The bottom line is, rising interest rates can, but do not have to, put a dent in your profitability, if you take the steps to survive and thrive in the new sales environment they create.