Auto Buyer’s Affordability Index:
Released: December 10, 2014
Phil Kelton, Requisite Press, LLC
The November 2014 Auto Buyer’s Affordability Index (ABAI) is 53.0 on a scale of 0 to 100. A score of 53.0 indicates that a U.S. median-income buyer following the 20-4-10 auto financing rule can only afford 53.0 percent of the November 2014 new-car average transaction price (ATP). This equates to a maximum affordable price of $16,143, assuming a median household income of $53,713 and an average transaction price (ATP) of $30,445.
In a survey of new-car buyers that have used long-term financing, Requisite Press found that nearly half of the buyers used the longer terms to purchase more expensive cars. At November prices, buyers that financed with a 6-year loan instead of 5-year loan could commit to an additional total cost of $6,016 while keeping payments the same. Given the November sales volume, long-term loans enabled extra spending of more than $1.4 billion, according to the study. Consumers with a lifetime of long-term loans could see a reduction in retirement savings of more than $140,000.
New-Car Buyer Survey
Requisite Press performed a survey, using Google Consumer Surveys, of 4,164 respondents regarding the use of long-term loans (61 months or more) for auto financing. Of those surveyed, 601 respondents indicated having used a long-term auto loan. Of the 601, 46.3 percent indicated they would have selected a less expensive car if a 60-month loan limit had been imposed. The margin of error is +4.2/-4.1 percent. Additional survey information can be found at Requisite Press Long-Term Loan Survey.
Auto Financing Trends and Simplifying Assumptions
According to the Experian State of the Automotive Finance Market report for the third quarter of 2014, 84.8 percent of vehicles were financed–either through loans or leases. Leases accounted for 29.14 percent of new financing. Given this data, vehicles finance with loans was calculated to be 60.1 percent.
The report indicated that 42.2 percent of loans were for terms of 61 to 72 months, while loans of 73 to 84 months made up 23.5 percent. To simplify this study, the percentages were added (65.7 percent) and assigned to the long-term loan group (61 months or more). This resulted in an assumption that long-term loans were used for 39.5 percent of vehicles purchased in November.
According to WardsAuto, 1.294 million light vehicles were sold in November 2014. Given the assumption for the percentage of vehicles financed with long-term loans (39.5 percent) as described above, an estimated 511,000 vehicles were financed with long-term loans in November. Based on the survey results, 46.3 percent of the 511,000 buyers used long-term loans to purchase more expensive cars–an estimated 237,000 vehicles in November.
November Extra Spending
An estimate of the extra spending per vehicle was calculated by comparing a 6-year loan and a 5-year loan with the same monthly payments. A purchase at the November average transaction price of $30,445, with a 10 percent down payment and six-year financing, results in a monthly payments of $463. The total cost commitment is $36,381, $6,016 more than a for 5-year loan with the same monthly payments.
Assuming extra spending of $6,016 on 237,000 vehicles, consumers used long-term loans to commit to an extra $1.426 billion in November.
The Impact to Personal Financial Security
If the one-time use of a long-term auto loan turns into a lifetime practice, the effect on personal financial security can be severe. Particularly if the spending would otherwise be invested in retirement savings.
Based on a lifetime of buying 8 cars using 6-year loans (each with extra spending of $6,016), a conservative 5 percent rate of return, and a retirement age of 67, the reduction in retirement savings would be $145,935. That amount may be significantly larger for some consumers.
For example, a car buyer that uses a 7-year loan, a significant percentage according to the Experian report, could commit to a total cost of $37,065. That’s $10,505 more than for a 5-year loan, assuming the same $405 monthly payment, as shown in the table below.
Using a $10,505 difference and applying the same conditions for lifetime buying, retirement, and rate of return, the reduction in retirement savings is $254,829.
Note: The reduction in retirement savings calculation assumes a new car is purchased every 7 years from ages 21 to 76. Interest on the spending difference is accrued starting with the 6th year of each 7-year cycle until the retirement age of 67. No interest accrues on the two purchases that occur after retirement.
Consumers can maximize their buying power and reduce the need to rely on a long-term loan with nonnegotiable competition at every step in the car buying process—sales price, trade-in, financing, and add-ons. In addition, following the 20-4-10 auto financing rule will preserve family financial security.
Sales price competition can easily be achieved—without the typical hassle—through the use of nonnegotiable e-mail quote requests. Dealers must go directly to their best price or risk losing the sale. Car buyers get the best market price without the hassle of back-and-forth negotiations.
Trade-in competition takes a bit more effort because a physical visit is required to obtain each offer. However, a nonnegotiable stance will still yield the best market price. The trade-in transaction should be kept separate from the new-car purchase—a different place and time—to insure that all offers are comparable.
Financing competition can easily be achieved by obtaining loan preapproval from a bank or credit union prior to visiting the winning dealership. Dealers may be able to beat the preapproved rate, given current dealer flexibility in setting retail profit margins. Either way, buyers will come out ahead.
Add-ons like vehicle service contracts (also referred to as extended warranties) and wheel/tire protection add thousands of dollars to the final cost of a new car, and often failed to return their full value. Requisite Press recommends that car buyers maintain emergency savings sufficient to cover any unexpected repairs rather than purchasing add-ons. Any savings that is not spent on repairs contributes to family financial security. However, in the event that a buyer decides to proceed with an add-on, price reductions can be achieved through competition as well. In most states, buyers can obtain better pricing on manufacturer-backed add-ons by inquiring with other franchise dealers. Many dealers specifically focus on selling add-ons to post-sale customers due to the market potential.
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 $53,713 and a monthly insurance premium of $130, the affordable monthly payment is $318.
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 $318, an interest rate of 3.99 percent, and a sales tax rate of 7.26 percent, the affordable price is $16,143.
The October 2014 ABAI was calculated by dividing the affordable price of $16,143 by the average transaction price of $30,455, and then multiplying by 100.
The affordable price result can be easily recreated by using AffordCheck℠:
Option: Check a quote, Yearly Income: $53,713, Local Sales Tax: 7.26%, Monthly Cost of Additional Cars: $0, Term: 48 months, Interest Rate: 3.99%, Bottom-Line Price: $16,143, Down Payment: $3,229, Yearly Insurance Premium: $1,560.
Returns a monthly payment of $318, and verifies a 20 percent down payment, 10 percent income, and corresponding Afford Score of 100.0.
New-Car Average Transaction Price
The average transaction price reference used is $30,445. The average transaction price estimate was published by Cars.com on December 2, 2014.
U.S. Median Household Income
The median household income used is $53,713. 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 November index is from the October 2014 Current Population Survey and was derived and published by Sentier Research, LLC on December 5, 2014.
Note: The November ABAI marks the return to using Sentier Research data. Sentier Research did not estimate median household income for August or September.
U.S. Average 48-Month Auto Loan Interest Rate
The interest rate used is 3.99 percent. The interest rate is the national average 48-month interest rate for November 13, 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 November 13th can be found at Yahoo.com.
U.S. Average Insurance Premium
The insurance premium used 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 is 7.26 percent. This rate is based on state average combined sales tax rates published by the Tax Foundation for the Midyear Update 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.