New-Car Affordability Idles As Both Prices and Incomes Move Downward
July 13, 2016
The June 2016 Auto Buyer’s Affordability Index (ABAI) is 59.2—marginally higher than May’s value of 59.1. The light-vehicle average transaction price (ATP) decreased by $304 in June to $30,536. However, the affordability gain due to lower prices was muted by a $137 decrease in the maximum affordable price as the U.S. median household income (MHI) moved lower. An ABAI of 59.2 indicates that a prudent, median-income household can only afford 59.2 percent of the new-car average price.
The ABAI continues to idle this year as moderating new-car prices are increasingly being met by contracting incomes. The ATP is down nearly 1 percent ($270) since February, and up only $42 year over year (June 2015). However, the MHI is down nearly 1 percent since February as well, having retreated from ground gained early in the year.
Median-income car buyers gained $167 of additional buying power (affordable price change minus the ATP change) in June even as the affordable price moved lower. Fortunately for car buyers, the ATP fell by $304, whereas the affordable price decreased by only $137. Car buyers have gained more than $2,500 of additional buying power 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 as market forces evolve. These forces include a moderating, and perhaps contracting, sales environment, and a growing supply of late-model used cars. Increasing price pressure will be offset by a continued supportive auto finance environment, but only in part.
Forecasts for 2016 new-car sales have hovered around 17.7 million since late last year. If achieved, sales will surpass the 17.47 million units sold in 2015, but the year-over-year growth rate will fall precipitously (1.3 vs. 6.3 percent). Just as this report was being published, LMC Automotive released an auto sales advisory indicating they have revised their forecast downward from 17.7 million to 17.4 million—40,000 fewer units than in 2015. With the market contracting, or at best, growing very slowly, market-share competition between automakers should continue to intensify, driving up incentives and holding down prices.
The supply of late-model used cars is anticipated to rise significantly this year—an increase of 800,000 units according to the NADA Used Car Guide. With leasing continuing at record levels, this growing supply trend will persist for the foreseeable future. Automakers have taken steps to offset the increased supply by promoting certified preowned sales, and by partnering with rideshare companies. However, it’s unlikely these efforts will be enough prop up prices. Moderating used-car prices should increasingly entice potential new-car buyers, putting additional pressure on new-car prices.
Fortunately for automakers, the auto financing environment continues to be supportive, for now. The average monthly payment amount, loan term, and loan amount remain at record highs, and interest rates continue at record lows. Industry analysts generally agree that the auto finance industry is in good shape. Some indications of concern exist, including a recent release by the Office of the Comptroller of the Currency stating that auto lending risk is on the increase. This is due, they say, to unprecedented growth, less stringent underwriting standards by some, and higher loan-to-value ratio/longer term combinations. However, the auto financing environment should continue to be supportive for the foreseeable future.
Affordability Improvement Depends on Income Growth
Given the current state of new-car pricing, affordability should begin to improve again if there is a return to income growth. However, recent economic news—a cut in the Federal Reserve’s U.S. economic growth forecast—may indicate that near-term income growth has become less likely.
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.