July Price Increase Steps On Income Gains, Causing New-Car Affordability to Falter
August 17, 2016
The July 2016 Auto Buyer’s Affordability Index (ABAI) is 58.9—down slightly from 59.2 in June. The median household income (MHI) rose $353 this month to $57,206, driving up the maximum affordable price to $18,268 (+$180). However, the affordable price gain was outpaced by a $503 increase in the light-vehicle average transaction price (ATP). An ABAI of 58.9 indicates that a prudent, median-income household can only afford 58.9 percent of the new-car average price.
Affordability improvement has stalled so far this year with a gain of only 0.5 points from January’s index value of 58.4. This compares to a 4.7 point increase over the same period in 2015 (52.3 to 57.0). Last year’s gains were due to supportive moves in both the MHI (+$715) and the ATP (-$747). This year’s smaller $385 MHI increase has been further muted by a $141 increase in the ATP.
Median-income car buyers lost $323 of buying power (affordable price change minus the ATP change) this month. Buying power has increased by $196 so far this year and $2,199 since January 2015 (see figure below).
Price Pressure to Continue Increasing
New-car prices will likely be subjected to increasing downward pressure throughout the remainder of the year due to plateauing new-car sales and increasing late-model used-car supply. These pressures should be somewhat muted in the near term by a supportive auto finance environment.
New-car sales forecasts universally predict, at best, a minimal increase this year—the smallest gain since the great recession. Most analysts expect sales to exceed last year’s totals and achieve record levels, but at a growth rate of around 1 percent, down from 6 percent in 2015. With little overall growth in the market, automakers are likely to increase incentives in a push for additional market-share.
The supply of late-model used cars is rising significantly this year—NADA Used Car Guide forecasts an increase of 800,000 off-lease vehicles. Used-car prices have remained strong throughout the first half of the year, but prices have begun soften and could decrease by 3 to 5 percent by the year end, according to Jim Hallett, CEO of KAR Auction Services. Lower used car prices are drawing some buyers away from new vehicles, according to Ford CFO Robert Shanks. In a time of plateauing new-car sales, a shift from new to used cars will further ratchet up pressure on new-car prices.
Fortunately for automakers, a favorable auto financing environment continues to soften the effects of price pressure—for now. The average monthly payment amount, loan term, and loan amount remain at record highs, and interest rates continue at record lows. However, some warning signs exist. For example, according to the Federal Reserve Board’s July Senior Loan Officer Survey, some bankers have tightened credit standards and rate spreads. Bankers cited economic uncertainty and reduced risk tolerance as important considerations.
Affordability Improvement Depends on Income Growth
Given the current state of new-car pricing, affordability should begin to improve in step with wage growth. However, the current U.S. economic outlook is mixed, and wage growth is likely to be muted.
Regardless of the state of overall affordability, each new-car buyer can preserve her own financial health by first ensuring that the purchase is affordable. Requisite Press recommends that consumers apply the 20-4-10 auto financing rule (see below) to more easily assess the affordability of a new-car purchase. Consumers can verify affordability throughout the car-buying process with 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.