“Follow the money” is one of the oldest truisms. Sooner or later, if you want to know the truth about something, or someone, or some industry, find out where the money is going, watch how it’s being raised, see how it’s being spent . . . and draw your own conclusions.
We’ve already seen how the US auto industry (and Europe’s, too, for that matter) is threatened by a tidal wave of vehicles coming off lease over the next few years, as well as technological obsolescence. Used car prices are predicted to drop by as much as 50% over the next few years, which will undoubtedly force new car prices to decrease as well – otherwise few will be willing to pay them, since the new-to-used differential will be so great.
There’s another reason why vehicle prices are going to have to drop. It looks as if many of us are struggling to afford them at any cost. The Wall Street Journal recently reported:
The average price of a new car is now $31,000, up $3,000 in the past four years. But at the same time, the average monthly car payment edged down, to $460 from $465—the result of longer loan terms and lower interest rates.
In the final quarter of 2012, the average term of a new car note stretched out to 65 months, the longest ever, according to Experian Information Solutions Inc. Experian said that 17% of all new car loans in the past quarter were between 73 and 84 months and there were even a few as long as 97 months. Four years ago, only 11% of loans fell into this category.
Such long term loans can present consumers and lenders with heightened risk. With a six- or seven-year loan, it takes car-buyers longer to reach the point where they owe less on the car than it is worth. Having “negative equity” or being “upside down” in a car makes it harder to trade or sell the vehicle if the owner can’t make payments.
There’s more at the link.
Jalopnik elaborates that there’s a significant downside to longer-term loans.
These extra-long car loan terms seem good for new car buyers because they help keep the payments down, ideally under $500 a month. But as the story notes, it takes buyers much longer to reach the point where they owe less on the car than it is worth.
In the meantime, you’re spending all that money each month for years at a time on a depreciating asset when it could be better spent on other things, like a mortgage or building up a savings account. You also may end up paying a ridiculous amount in interest over those years.
Again, more at the link.
Think about it.
- 73 months = 6 years, 1 month – 50% longer than most people spend in high school, or to earn a 4-year undergraduate degree.
- 84 months = 7 years – even worse.
- 97 months = 8 years, 1 month – twice as long as most people spend in high school, or take to earn a 4-year undergraduate degree.
That’s an awful long time to burden oneself with an auto loan, on top of existing debt such as study loans, credit cards, lines of credit, etc. (to say nothing of a housing loan). What if you want to get married during the term of your auto loan? You now have to carry that expense into your new (and hopefully lifelong) relationship, burdening your partner with it, even though the vehicle you bought may not be suitable for a couple (particularly if they plan to have children). If you need a more suitable vehicle, as Jalopnik warns, you may be ‘upside-down’ on your loan (i.e. owe more than the vehicle is worth), and therefore have to take out an even larger loan to buy what you need.
There’s another factor to consider. I’ve written on many occasions about the real rate of inflation, as compared to the ‘official’ rate (which is deliberately understated to a ridiculous extent, so as to hold down mandated-by-law increases in entitlement costs). The inflation-adjusted cost of a motor vehicle is claimed to be relatively constant over time. (Click the chart for a larger view.)
However, average US incomes have not kept pace with the real level of inflation over time. Even using the deliberately-skewed, politically-correct, understated ‘official’ inflation rate, the bottom three quintiles show a decline:
When one uses a more realistic measurement of inflation, as we discussed last year, the inflation rate – and the resultant decline in effective household income – is far greater. Put in its simplest terms, most US households currently have significantly less disposable income, in terms of the buying power of their money, than they had in previous decades. Therefore, while auto prices may have held reasonably steady in inflation-adjusted dollars, the incomes of those who buy them have not. They’re now effectively much lower. (If you doubt this, do your own measurement. Compare the cost of typical groceries and supplies for your household in 1997, in 2007, and this year. I guarantee you, the cost difference will be much greater than can be accounted for by the official rate of inflation! My wife and I reckon our expenses for normal household groceries and supplies have more than doubled over the past ten years; yet our personal incomes have not grown to anything like the same extent. I’ll be surprised if you haven’t seen something similar.)
That’s why the duration of auto loans has had to increase. People no longer have sufficient disposable income to afford both their normal living expenses, and the monthly payments on that auto loan over a more ‘conventional’ term. That’s also why many US cars are now sold through short-term leases rather than auto loans – because loan payments are simply too high. To take a wider perspective, it’s also why most housing mortgages have stretched from fifteen to thirty years, in most cases, and why most people can’t afford to put down a deposit of more than one or two per cent on their homes – and therefore are very, very vulnerable to another housing downturn. (When Miss D. and I bought our house in Texas, a year and a half ago, I was told by the bank official handling our loan application that we were the first couple in six months to have taken out a 15-year loan, putting down a 20% deposit. This is, apparently, simply impossible for most couples today. That’s a very scary thought!)
Putting all those factors together, I’d say the US auto industry is in very serious trouble indeed. Many of its customers simply can’t afford its vehicles at their current price levels; and even those who can, often have to stretch out their auto loans to unconscionable lengths to reduce the monthly payment, thereby crippling themselves with additional interest charges (and affecting their ability to access other forms of credit, for the duration of the auto loan). In order to sell cars to those who can’t afford even such extended payment terms, the industry has hamstrung itself by leasing millions of vehicles. As those short-term leases expire, they will vastly increase used-car inventories, making it impossible to both resell them all, and simultaneously sell more new cars, all at present, inflated prices. The industry has been hoist on its own petard.
Herbert Stein famously said that “If something cannot go on forever, it will stop.” I rather suspect that’s about to happen to the US auto industry in its present form. Unless it changes, it’ll simply price itself out of its own market . . . and that’ll leave it nowhere to go.
Cars have become more expensive in part because of never ending government regulations for 'mo safety' and fractional decreases in pollution. I owned a used '95 Buick LeSabre with a V6 that had better gas mileage than most 4 cylinders do today.
One would have thought that despite commodity prices, cars would have become cheaper but have not. Eric Peters Autos has written about this many times.
Remember the Honda CRX 2 door, Geo Metro, and Ford Fiesta from the 90's? You can't build those cars today because you 'da safety'.
Here is a blog I like to read of a lady out in CA. Here she discusses the 'ghost lots' of car inventory of various brands.
I thought hey, what a great combo. A declining car industry needing to park it's inventory in empty mall and retail centers.
I had long thought that the Obama "Cash for Clunkers" program was an attempt to dry up the used car market, and force people to buy new cars, ideally, a "green" car. However, I hadn't considered the effect of a massive amount of short-term leased cars being put on the market would have. The only analogy I have is the periodic sales of rental fleet cars I've seen in my area, but everyone knows to avoid them. (If a rental car company doesn't want the car, why would you want it?)
So the question I have about the short-term lease cars returning to market is the same one you pose in your article. How does the car company avoid being "upside-down" in the value of their car, versus the depreciation. Although I could see them being used as "loss" assets to offset profits on the balance sheet.
My sister went on a mission trip to Argentina in 1980. They took out 20 year loans on cars down there. I remember my shock at that. We are working our way to that point…..
You leave out another factor: Our me now hurry want want want society. No one is willing to pace themselves, save up for a down payment on a car, much less a house. We started off as newlyweds by keeping a car 2 years or more longer than our loan. We kept paying into a savings account for the down payment on the next car. Within about 2 cycles we had cash for buying the new car…no loan required. No one else I know would do something like this. If they manage to pay off their car they 'take the raise' and live large until their car craps out, then they suffer and whine at the lifestyle cutbacks required to start a new car payment…or the next car they buy is so much more expensive it wipes out the gains.
Simple discipline. So lacking in most every sector in our society any more, but particularly in finance and lifestyle…but after all, if our government can't do it why should the masses.
First, as I've mentioned before, I see nothing wrong with a longer loan term if you are using that payment reduction method as "insurance" to prevent missing higher dollar payments and make much higher payments to get out of the loan sooner.
I've always financed autos for 60 months and paid the loan off in 24-30; if you are not in a position to do that, you should re-think your transportation alternatives before you shackle yourself to a such a long term commitment. I do question longer term loans on something that you know will wear out and require replacement, potentially during the loan period. It's one thing to finance a house for 30 years and pay it off in 13-16; it's entirely different to finance a freaking car for 72, 84 or 96 months. Houses are investments, and they – traditionally – appreciate over time; cars are consumable commodity goods that depreciate over time.
Second, I'm wondering if the bottom dropping out of the auto manufacturing business – which it certainly will when the price of cars, even new ones, falls by 25-40% – might be the trigger which collapses the economy into a deflationary death spiral. For a while now lenders have been making unsecured, or very poorly secured, car loans to prop car sales up, and auto manufacturers still have a record number of cars in inventory. I don't think the size of the car loan bubble equals the size of the home loan bubble of 2005-2007, but given the fragility of the economy it probably doesn't have to to pose a dire threat.
For me, the Obama cash for clunkers ruined the used car market. It doubled or tripled the cost of used cars. That was always the market we sought. Just try to find a good running car for $1000 or less now. Few and far between.
And Bush should not have done the first Detroit bailout. It set a stupid precedence.
The government has had its fingers in too many businesses being forced out of business. They had no right. The market should decide.
I appreciate your post. Thank you and God bless.
Only thing worse than buying a depreciating asset is … FINANCING a depreciating asset.
I work in an auto repair shop. I will never buy a previously-leased car. When otherwise sensible people know they're going to turn in a nice car and walk away unscathed, they neglect and abuse them–putting in the cheapest oil, avoiding routine maintenance, etc. At least a used car has a chance of being valued by the previous owner.
David Lang writes:
The Texan nailed it, cars are more expensive because of all the new "but it's good for you" requirements, and they eventually price themselves out of people's price range.
'Cash for clunkers' again… as long as we "need" cars we'll find the money.
One factor not mentioned is unions. Manufacturers don't have the flexibility to curb output when needed because unions won't stand for workers being laid off. So the conveyor belt keeps cranking out cars because it has no choice. Unions are short-sighted and are doing their best to kill the car industry. They're not the only villains, but they're right up there.
Unless your car is also your hobby & you're willing to pay extra for that enjoyment, or you're affluent enough you can afford to pay a premium price for a luxury, buying a new car rather than a recent model used car doesn't really make sense.
I've bought a couple of new cars over the years. The first was a mistake (young and stupid), the second was actually a good move, but only because the maker was offering ridiculously low pricing and an incredible warranty to gain market share (Hyundai, 11 years ago – daughter #2 is still driving it). But barring similar special circumstances wife and I always look for decent used cars first. We've saved a *lot* of money over the years.
Though I suspect we're outliers – too many of my friends and relatives seem to automatically go for a new car even when it stretches their finances to the breaking point. Still trying to understand why they think buying a new crew-cab truck that costs more than half their annual income makes sense, especially when all they ever haul is people or groceries.
"Still trying to understand why they think buying a new crew-cab truck that costs more than half their annual income makes sense, especially when all they ever haul is people or groceries."
For the same reason they buy 4x4s that never leave the asphalt, or wear North Face parkas from their vehicle to the office. It's all about image, of how they like to think of themselves. There's a big difference between "I like this" and "I'm like this".
" Unions are short-sighted and are doing their best to kill the car industry. They're not the only villains, but they're right up there."
No, they are the primary villains as far as the auto industry is concerned. THEY are the reason that so much of manufacturing here in the US got so comfortable in outsourcing to other countries. As a consequence, most of the content of US brand vehicles are made elsewhere. THEY are the reason that Detroit died. US style labor unions are the worst thing that ever happened to our nation.
"The Texan nailed it, cars are more expensive because of all the new "but it's good for you" requirements, and they eventually price themselves out of people's price range."
In the early 80's, I saw a cute little 4×4 that looked like a 3/4 scale jeep. Brought home from Guam by a soldier. A few years later, they began importing them, but the price was 3x what that soldier paid. His was a bare bones unit, and I thought they would sell many millions if they brought them in. What they sold was too fancy, and while they sold well, not nearly as well as they could have.
Which reminds me, a friend got hired as a district rep for Mercedes a few years before that, and told me that they basically tripled the price of cars that they sold here, compared to the rest of the world.
joek, that was a rhetorical question, really.
I make rather more money than my brothers (fortunate choice of career fields, mostly). But at any given time I probably drive the least expensive / prestigious car. Combination of being frugal/cheap and not being a car nut (I grew up on motorcycles – and even a mid-range commuter bike can best most sports cars' acceleration and handling).
But when your dream vehicle is a mid-70's BMW touring bike or mid-60's Triumph Bonneville, it's remarkably easy to resist the urge to buy a new car every few years.
Just watched my nephew go through 3 new cars in the last 4 years, just so he could trade up to the latest luxury truck. Which he'll use nearly exclusively for commuting ~100 miles a day. Oy!
Three new cars in four years?! What a waste of money.
(my apologies, BTW. I figured that was a rhetorical question ; I should have acknowledged it as such)
I do agree that the auto unions have a lot to do with the car problems. Unions were needed once, but I don't like them. I think they have outlived their usefulness.
Manufacturers don't have the flexibility to curb output when needed because unions won't stand for workers being laid off.
Well, you see, they don't actually need to lay off auto workers to curb output.
What they need to do is curb output, and set the auto workers (who would be laid-off) to dismantling the excess inventory.
They could then hand whatever parts were still good to the assembly line, who could bolt them on new vehicles. (Maybe they'd call them re-manufactured?)
This would save auto companies a bundle on storage and new parts manufacture.
Morale? We don't need no stinking morale!