May New-Car Affordability Flat As Income Growth Stalls
June 15, 2016
The May 2016 Auto Buyer’s Affordability Index (ABAI) is 59.1, unchanged from last month. The maximum affordable price drifted down by $4 as the U.S. median household income (MHI) decreased by $20. However, the affordable price decrease was offset by the same $4 decrease in the light-vehicle average transaction price (ATP). An ABAI of 59.1 indicates that a prudent, median-income household can only afford 59.1 percent of the new-car average price.
The ABAI has essentially stalled since reaching 59.2 in February 2016 (see figure below), after increasing more than 6 points in 2015. This recent slowdown in affordability improvement is largely due to an absence of income growth—the MHI is down $45 since February. New-car prices have continued to trend flat with year-over-year ATP growth of less than 0.5 percent.
No additional buying power (affordable price change minus the ATP change) was gained in May due to the offsetting decreases in the ATP and affordable price. However, median-income car buyers retain the $2,355 in buying power gained since January 2015 (see figure below).
Price Pressure to Continue
New-car prices should continue to be weighed down by market conditions throughout the remainder of the year. U.S. new-car sales forecasts for 2016 continue to point to a significant reduction in the growth rate (1.3 percent vs. 6.3 percent in 2015). As a result, market-share competition between automakers should continue to intensify, driving up incentives and holding down prices. May incentives were up 13 percent year-over-year.
Used-car prices continue to ease downward as the supply increases, consistent with forecasts for 2016. Moderating used-car prices continue to entice potential new-car buyers, putting additional pressure on new-car prices. Some evidence of this may already be seen in a recent shift of prime borrowers from new cars to used cars. According to Experian Automotive, prime borrowers chose used cars 54.5 percent of the time in the first quarter of 2016 (Q1 2016), up nearly 5 percent year-over-year.
Auto financing will continue to support new-car prices in the near term. The average monthly payment amount, loan term, and loan amount are all at record levels. In addition, a record number of consumers are choosing leasing. However, a shift may have begun. As of Q1 2016, the percentage of 30-day and 60-day delinquencies and delinquent balances, as well as the average new-car loan rate, are all increasing according to Experian Automotive.
Affordability Improvement Depends on Income Growth
Given the current state of new-car pricing, affordability should begin to improve again if incomes return to last year’s upward trend. However, recent economic news—the May jobs report in particular—may indicate that income growth will remain flat. A lack of income growth will likely lead to stagnant new-car affordability.
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.