New-Car Affordability Rises 9 Percent as Incomes Outpace Prices
July 15, 2015
The Auto Buyer’s Affordability Index (ABAI) rose to 57.4 in June 2015, an increase of 8.9 percent year-over-year (YOY). The improvement in new-car affordability was largely driven by a rise in the median household income (MHI)—up $1,807 from the June 2014 index. A moderating tend in new-car prices also contributed to the improvement as the light-vehicle average transaction price (ATP) increased by only $152 YOY. As a result of improved affordability, median-income shoppers entered the market with an additional $1,371 of buying power (the difference in the change of the maximum affordable price and the ATP).
The ABAI increased each month in the first half of 2015, including a 2.1 percent increase in June. Both income and price moved in a supportive direction in June with a MHI increase of $614 and an ATP decrease of $208.
Even as new-car affordability improved, car buyers borrowed greater amounts for a longer duration. According to Experian Automotive, the average amount financed in Q1 2015 rose to $28,711, up $1,099 YOY. The average loan duration increased from 66 months to 67 months, including an 18.6 percent increase in 73 to 84 month loans.
Long-term loans are often promoted as a way to make new cars more affordable. The risk of long-term loans—a greater period of negative equity—is downplayed by a comparison to the increased operating life of today’s cars. However, consumer-centric automotive technology is rapidly evolving with major enhancements anticipated in the near future. These include significant improvements in the driver experience and vehicle safety, including the integration of internet resources, active safety and driver assist features, and vehicle-to-vehicle communication.
Some of these technologies will be required by law, like the 2018 mandate for backup cameras. Others will affect safety ratings, like the recent push to integrate collision avoidance capability into the National Highway Traffic Safety Administration (NHTSA) crashworthiness rating. According to the National Transportation Safety Board (NTSB), only 4 out of 684 passenger vehicle models in 2014 included a complete forward collision avoidance system as a standard feature.
As a result of the unprecedented rapid advance of technology, a new car purchased in 2015 may simply be deemed to be undesirable by 2021. However, some new-car buyers could be locked into such a vehicle due to an extended period of negative equity.
Car buyers can preserve their ability to upgrade as technology evolves by ensuring the overall affordability of their purchase. Requisite Press recommends that consumers use a rule of thumb, such as the 20-4-10 auto financing rule (see below), to more easily assess affordability.
Consumers can keep track of affordability throughout the car-buying process by making use of AffordCheck℠, a free online tool based on the 20-4-10 rule. AffordCheck℠ can be used to determine an affordable price range, and it can also be used to assess specific offers as they are received.
20-4-10 Auto Financing Rule
The 20-4-10 auto financing rule consists of a minimum 20 percent down payment, a maximum 4-year loan term, and monthly payments of no more than 10 percent of gross household income (including insurance). The rule is widely recommended by personal finance experts to maintain financial security, avoid excessive interest costs, and preserve future investment opportunities.
The affordable monthly payment (including principal and interest) is calculated by taking 10 percent of the U.S. monthly median household income and subtracting a U.S. average monthly insurance premium. The affordable price is then calculated using the affordable payment, along with a U.S. average 48-month auto loan interest rate and a U.S. average sales tax rate. A 20 percent down payment is assumed. The ABAI is calculated by dividing the affordable price by the average transaction price and then multiplying by 100.