Auto Buyer’s Affordability Index:
Released: November 12, 2014
Phil Kelton, Requisite Press, LLC
The October 2014 Auto Buyer’s Affordability Index (ABAI) is 54.1 on a scale of 0 to 100. A score of 54.1 indicates that a U.S. median-income buyer following the 20-4-10 auto financing rule can only afford 54.1 percent of the October 2014 new-car average transaction price (ATP). This equates to a maximum affordable price of $16,448, assuming a median household income of $54,457 and an ATP of $30,382.
New-car sales and transaction prices have largely recovered since the Great Recession. However, transaction prices have recently begun to weaken under ideal conditions for strength. The current pricing trend, taken in context of historical data (1970 – present) as shown in Figure 1 below, could signal an end to 35 years of prices outpacing incomes. American consumers may no longer be able to afford the new-car price premium. New-car affordability is likely to improve in the near-term if the current rate of income growth continues.
Price Increase Slowdown
U.S. light vehicle sales and average transaction prices have made significant gains since the depths of the Great Recession. Sales have grown by nearly 60 percent from a 2009 low of 10.4 million units to a projected 16.4 million this year, within 6 percent of the record set in 2000. The average new-car expenditure hit record levels in 2010, and nearly returned to pre-recession growth trends in 2011, according to U.S. Bureau of Economic Analysis (BEA) data. However, the rate of increase has slowed each year since 2011. New-Car prices are likely to decrease this year for the first time since 2009, based on BEA data through September.
Ideal Conditions for Strength
New-car prices are weakening under ideal conditions for price strength. Auto loan rates and terms, and leasing have all been supportive to increased consumer spending this year.
The average 48-month loan rate (Bankrate.com) has remained near 4% throughout the year, near record lows. The average loan duration rose to 66 months in the 2nd quarter, according to Experian Automotive. Most credit unions and some banks now regularly make 84-month auto loans, previously seen as a bad idea by auto manufacturers, dealers, and the finance industry. Ford Credit, the second-largest new-vehicle lender, joined the rush to long-term loans, with an October 1st announcement of a new 75-month loan program.
“Financing is getting out of hand with 72-, 84- and 96-month loans,” says William Underriner, chairman of the National Automobile Dealers Assn. “The customer will always be upside-down on the car.”
WardsAuto, March 7, 2012
Steve Szakaly, chief economist with the National Automobile Dealers Association, said longer loan terms were “reasonable and normal” given that cars are now build better and last longer.
New York Times, November 5, 2014
Leasing, once primarily the choice of luxury car buyers desiring the latest model, has gone mainstream. Total lease originations in 2014 are expected to be nearly one million greater than pre-recession highs of 2.5 million, according to Kelly Blue Book. Consumers are increasingly turning to leasing to drive cars that would otherwise break the monthly budget.
Change is Coming
These supportive economic conditions will not last forever, and will likely begin to erode in 2015.
An increase in the Federal Funds Rate is anticipated by the summer of 2015. While not directly tied to auto loan rates, the increase will signal conditions that will drive auto loan rates higher.
Financing risk is growing with 60-day delinquency rates up 7 percent in the 2nd Quarter, year over year, according to Experian Automotive. Delinquency rates are still well below pre-recession levels. However, a 70 percent jump in repossessions over the same period may signal tighter post-recession acceptable risk levels. As credit tightens, consumer spending will moderate.
The growing supply of used cars may become an additional source of downward pressure on new-car prices. In July, ALG forecasted a used-car supply increase of 2.7 million units by mid-2017 and a corresponding 5 percent drop in used-car values. Values have already begun falling with a drop of 2 percent in the 3rd quarter, according to a Manheim. Many franchise dealers are increasingly focused on growing their profitable used-car sales businesses, further amplifying the competitive effect.
Pricing in Context
A review of new-car prices and incomes beginning in 1970 shows that for 35 years, from 1980 to the present day, the average new-car expenditure has maintained a greater increase than median household incomes. The decade of the 1970s was marked by prices and incomes moving up at similar rates, both up about 90% over the course of the decade. This trend shifted in 1980, with prices growing faster than incomes. By 1992, the average expenditure had increased by 361%, whereas median household income had only grown by 251%, a difference of more than 100%. This difference has been maintained throughout the years since, except for a brief drop to 85% and 87% during 2008 and 2009, respectively.
After the Great Recession, the difference reached a new maximum of 147% in 2011 as prices recovered faster than incomes. However, the difference has fallen every year since 2011, and based on Requisite Press estimates, is anticipated to fall below 100% for 2014. If so, this will be the first year since 1991, excluding the Great Recession years, with a difference of less than 100%.
Consumers May Be Maxed Out
During this same 35-year period, the personal savings rate has fallen from 10.6 percent in 1980, to 5.6 percent as of September 2014. While a number of conditions have contributed to this change, the general trend of increased personal spending has certainly helped preserve the new-car price premium.
It’s unclear whether consumers can maintain this level of spending into the future.
The first baby boomer reached retirement age in 2011 and kicked off a wave that will culminate in a 76% increase in people age 65 or over by 2030—fully 20% of the American population. Many are underprepared for retirement, and are likely to have insufficient savings to preserve their desired standard of living.
At the other end of the scale, the Millennial Generation, with ages up to 32, has taken on larger amounts of college debt than previous generations, and must deal with unemployment levels that have remained high since the Great Recession. The debate continues about their interest in driving cars, but millennials clearly don’t have the resources to push new-car prices up.
The American consumer may no longer be able to afford the new-car price premium.
Opportunity for Car Buyers
If the pricing trend from 2011 to 2014 continues into 2015 and beyond, and the current rate of household income growth continues, new-car affordability will improve in the near term. The timing and amount of improvement is difficult to estimate. An increase in the selection of affordable models is best obtained through competition, however improved affordability will give an additional boost to buyer choice.
Consumers can maximize their buying power, no matter the economic climate, with nonnegotiable competition at every step in the car buying process—sales price, trade-in, financing, and add-ons. 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 be easily 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.
New-Car Average Expenditure
The new-car average expenditure per year from 1970 to 2013 is a 12-month average of monthly data from the Bureau of Economic Analysis, Table 7.2.5S Auto and Truck Unit Sales, Production, Inventories, Expenditures, and Price, line 40.
The 2014 estimate is a nine-month average of the BEA data for January through September 2014.
The BEA light truck average expenditure data (line 21) was not used in the review. Table 7.2.5s begins including the light-truck average expenditure in 2002, making a comparison to a 1970 reference impossible. However, a review of combined car and light truck average expenditure from 2002 through 2014 indicates a trend similar to cars, if somewhat moderated in 2014 by an increase in the light-truck average expenditure.
Median Household Income
The Median Household Income from 1970 to 2013 is from the U.S. Census Bureau Historical Income Tables for Households, Table H-5 All Races, Current Dollars column.
The 2014 Median Household Income estimate was established by adopting the Sentier Research, LLC estimate for June 2014.
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 $54,457 and a monthly insurance premium of $130, the affordable monthly payment is $324.
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 $324, an interest rate of 3.99 percent, and a sales tax rate of 7.26 percent, the affordable price is $16,448.
The October 2014 ABAI was calculated by dividing the affordable price of $16,448 by the average transaction price of $30,382, and then multiplying by 100.
The affordable price result can be easily recreated by using AffordCheck℠:
Option: Check a quote, Yearly Income: $54,457, Local Sales Tax: 7.26%, Monthly Cost of Additional Cars: $0, Term: 48 months, Interest Rate: 3.99%, Bottom-Line Price: $16,448, Down Payment: $3,290, Yearly Insurance Premium: $1,560.
Returns a monthly payment of $324, 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 $30,382. The average transaction price estimate was published by Cars.com on November 3, 2014.
U.S. Median Household Income
The median household income used is $54,457, based on a simple curve fit forecast using Sentier Research estimates for January 2014 through July 2014. Sentier Research did not publish median household income data this month due pending analysis of the effects of changes in the Current Population Survey sample design.
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 October 16, 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 October 16th 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.