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July 2014 Auto Buyer’s Affordability Index

August 6, 2014

Discussion

The July 2014 Auto Buyer’s Affordability Index (ABAI) is 53.5 on a scale of 0 to 100. A score of 53.5 indicates that a U.S. median-income buyer following the 20-4-10 auto financing rule can only afford 53.5 percent of the July 2014 new-car average transaction price (ATP). This equates to a maximum affordable price of $16,175, assuming a median income of $53,891 and an ATP of $30,210.

July’s ABAI is up 1.5 percent from the June 2014 ABAI of 52.7. The change was largely due to an increase in median household income, up 1.0 percent from last month.

New-car prices have outpaced income growth during the five years of economic recovery (2009 through 2013) since the Great Recession. The average new-car price grew by 8.9% according to the Bureau of Economic Analysis (BEA Table 7.2.5S, Line 40) data, while the median household income increased by only 4% according to the U.S. Census Bureau, Current Population Survey data.

Fortunately for consumers, the new-car marketplace has seen significant modernization during the same time period. While much of the industry’s focus has been on technology, with the growth of online buying services and enhanced dealer websites, the most valuable development for consumers has been the industry-wide acceptance of emailed quote requests. This enables easier buyer access to a sufficient number of sources to benefit from the commodity nature of a new car.

Most new cars are produced in large quantities, are widely available, and are essentially commodities. For example, any Ford model can be purchased from more than 3,000 Ford dealerships, nationwide. The difficulty has been access–it just took too much effort to obtain quotes from more than a few sources. With access effectively limited, new cars took on the characteristics of a unique, limited-supply product. Negotiation, high prices, and an unpleasant experience were typical.

Consumers have benefited from expanded access and the commodity effect through lower prices and a better buying experience. Easy access to multiple sources eliminates the need for negotiation. Buyers can request best-price, nonnegotiable quotes and quickly obtain the best market price. Bids from multiple sources are typical, providing the consumer with the choice and flexibility that leads to a better buying experience. There is simply no longer a reason to choose between a great price and a hassle-free experience.

Consumers can maximize the commodity effect by preparing for an immediate purchase, writing a quote request email that demonstrates that readiness, and requesting quotes from seven to ten sources.

Preparing for an Immediate Purchase

Readiness includes selecting the model, trim, and options. The manufacturer’s website is a good source for available configurations and standard terminology. This will enable the buyer to clearly communicate the selection.

Pricing data should be obtained to confirm affordability as well as to prepare a reference for comparison of quotes. Publically available pricing data typically includes invoice pricing for model trims and options, holdback information, manufacturer to buyer incentives, and some manufacturer to dealer incentives.

A test drive should be conducted to confirm the suitability of the car. Cars that seem appropriate based on videos, pictures, reviews, and data may not look the same in the light of day, or drive as expected.

If financing the purchase, buyers should obtain loan preapproval while preparing. A preapproved loan will ensure a competitive financing rate offer.

The Quote Request Email

Buyers can write one email and then quickly personalize for each source. The email should demonstrate that the buyer is informed and ready to make an immediate purchase. However, a target price should not be included. A quote request email template, along with element descriptions, can be seen by clicking on the image below.

PS Quote Request

Multiple Sources

When nonnegotiable quote requests are used, the resulting quotes are essentially sealed bids. As the number of bidders increase, the reserve margin naturally drops. With new-car buying, there is an additional reason to obtain multiple quotes. While large dealership groups are highly visible, including profitable public entities, the majority of sources are independent businesses that operate with varying degrees of business success. There is no easy way to determine up front which sources can afford to offer the best market price.

Sources should be screened to avoid wasted time and effort. As with all businesses, there are new-car sources that are disreputable. Independent assessments based on clear guidelines, such as those provided by The Better Business Bureau, is a good way to filter out problematic sources.

Seven to ten sources are a reasonable number to obtain the commodity effect and still be manageable by consumers. More sources will likely yield better results–an option open to buyers that are willing to take on the added effort.

ABAI Methodology

The monthly ABAI was developed to enable buyers to easily view current new-car prices in the context of sound financial advice. 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. The rule is widely recommended by personal finance experts to maintain financial security, avoid excessive interest costs, and preserve future investment opportunities.

An affordable monthly payment (including principal and interest) was calculated by taking 10 percent of the U.S. monthly median household income, and subtracting a U.S. average monthly insurance premium. For an income of $53,891 and a monthly insurance premium of $130, the affordable monthly payment is $319.

An affordable price was 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 was assumed. For a payment of $319, an interest rate of 4.06 percent, and a sales tax rate of 7.24 percent, the affordable price is $16,175.

The July 2014 ABAI was calculated by dividing the affordable price of $16,175 by the average transaction price of $30,210, and then multiplying by 100.

The affordable price result can be easily recreated by using AffordCheck℠:

Option: Check a quote, Yearly Income: $53,891, Local Sales Tax: 7.24%, Monthly Cost of Additional Cars: $0, Term: 48 months, Interest Rate: 4.06%, Bottom-Line Price: 16,175, Down Payment: $3,235, Yearly Insurance Premium: $1560.

Returns a monthly payment of $319, and verifies a 20 percent down payment, 10 percent income, and corresponding Afford Score of 100.0.

Sources:

New Car Average Transaction Price

The Average Transaction Price reference used in the July 2014 index is $30,210. The price reference for July 2014 is an average of estimates by Cars.com and Truecar.

July 2014 ATP Table Final

Press release links: Cars.com, Truecar

U. S. Median Household Income

The median household income used for the July 2014 index is $53,891. The median household income is published by Sentier Research, LLC on a monthly basis based on the Current Population Survey data. There is a one-month lag in publishing the data, so the latest available data for the July index is from the June 2014 Current Population Survey and was derived and published by Sentier Research, LLC on July 28, 2014.

U.S. Average 48-Month Auto Loan Interest Rate

The interest rate used in the July 2014 index is 4.06 percent. The interest rate is the national average 48-month interest rate for July 17, 2014 published by Bankrate.com based on a weekly survey of large banks and thrifts. Bankrate.com does not keep an archive of past 2014 rates. However, the Bankrate.com rates for July 17th can be found at Yahoo.com.

U. S. Average Insurance Premium

The insurance premium used in the calculation of the July 2014 index is $130 per month. The premium is based on state average insurance premiums published by Insure.com for 2014, and then weighted by state population to develop a national average. The state population estimates are from the Census Bureau’s Population Estimates Program, Annual Estimates of the Resident Population: April 1, 2010 to July 1, 2013, 2013 Population Estimates (ID PEPANNRES).

U. S Average Sales Tax Rate

The sales tax rate used in the calculation of the July 2014 index is 7.24 percent. This rate is based on state average combined sales tax rates published by the Tax Foundation for 2014, and then weighted by state population to develop a national average. Population numbers used were identical to those used for the insurance premium calculation.