New-Car Affordability Regains Ground in August as Prices Dip
September 14, 2016
The Auto Buyer’s Affordability Index (ABAI) rose to 59.2 in August, regaining ground lost in July. The improvement was driven by a $227 decrease in the light-vehicle average transaction price (ATP). Median household income (MHI) inched downward to $57,190, a decrease of $16, but had little effect on affordability. 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 new-car affordability index has stalled out at around 59 this year after rising rapidly from the low 50s in 2015. The lack of improvement this year is largely due to a stagnant MHI—down $98 since February. By comparison, the MHI rose $801 last year through August and $2,329 for all of 2015. Fortunately for consumers, prices have also been flat this year.
Buying power (affordable price change minus the ATP change) rose $213 due to the decrease in prices, but didn’t fully recapture the July decrease. Buying power has increased by $409 so far this year—primarily due to a February increase of $393. (See figure below.)
Price Pressure Continues
New-car prices remain under pressure due to plateauing new-car sales and an increase in the late-model used-car supply. These pressures have been somewhat muted by a continued, supportive auto finance environment.
New-car sales forecasts universally predict, at best, a minimal increase this year—the smallest gain since the great recession. As of September 1st, year-to-date sales are up by only 70,000 units (0.6 percent). This comes after six years of growth in excess of 5 percent. With little overall growth to be had, incentives are on the rise as automakers 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 fairly strong thus far, but prices have begun soften and could decrease by 3 to 5 percent by the end of the year, according to Jim Hallett, CEO of KAR Auction Services. According to Experian Automotive, borrowers chose used cars a record 55.61 percent of the time in the second quarter. In a time of plateauing new-car sales, a shift from new to used cars further ratchets up the pressure on new-car prices.
Fortunately for automakers, a favorable auto financing environment is muting 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, Gordon Smith, the CEO of JPMorgan Chase’s consumer and community banking segment, recently said that the company is reducing lending in the 84-month term category as a hedge against an economic downturn.
Affordability Improvement Depends on Income Growth
Given the current state of new-car pricing, affordability should improve as incomes increase. However, the current U.S. economic outlook is mixed, and potential for wage growth is uncertain.
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.