Recently, the Wall Street Journal highlighted that new car affordability is becoming more elusive each year. With new technology and sophisticated features, cars have an average ticket price of more than $32,000 and a monthly payment of $523.
To pay for this, people are increasingly turning to long-term loans. According to credit reporting company Experian, more than 30% of new car loans are longer than six years. The average loan is now 69 months.
Who can blame them? The smell of a new car, with its gleaming paint, is hard to resist. How did we ever get along without satellite radio, all-electric everything, a sunroof and leather trim on every surface?
With the average American making less than $47,000 per year, car payments are swallowing more than 13% of their gross income.
There are two culprits allowing this to happen. First, car dealers are making more money on finance charges than on the actual sales price of cars. According to data analytics company J.D. Power, dealerships make nearly $1,000 per new vehicle on finance and insurance charges versus $381 on the actual sale.
Secondly, as interest rates have declined, Wall Street’s appetite for buying up packages of higher-yielding auto loans has surged. According to the Federal Reserve, in the last 10 years U.S. consumer auto debt surged from $740 billion to $1.3 trillion.
Wow! This sounds amazingly similar to what happened when Wall Street encouraged profligate lending on homes so they could package mortgages with increasingly weak credit standards. How quickly we forget.
Additionally, late in the life of a six- or seven-year auto loan, higher-ticket items will start to break. The options are limited. If consumers are not good savers, the cost of repair often gets lumped onto a credit card.
Other times, people fall prey to making the situation worse by rolling the existing negatively amortized debt into a new, larger and longer auto loan. According to car-shopping site Edmunds, a third of new car buyers roll their debt from an old car to a new one.
Car dealers are more than happy to facilitate this trade knowing that once consumers start down this slippery path, it is very hard to break the habit.
How does one break this financing cycle and still afford a reliable ride?
First, don’t buy a new car. This was true 10 years ago, and it is true today. Cars are depreciating assets, and yet they have become more and more reliable.
According to Edmunds, a new car depreciates 11% the second you drive it off the lot. It then depreciates an average of 15% to 25% per year for the next five years.
As such, a car that is five years old will only run 37% of the new car price.
Experian says vehicles in the 6-12 year range are in the “sweet spot.” They are reliable yet significantly cheaper to own than a new car.
A couple of ideas to consider come from Toyota, Honda and Hyundai:
A base model 2010 Toyota Corolla with 115,000 miles on it can be purchased for $6,500. The same year Honda Accord will be in the $7,000 price range. A Hyundai Elantra with about 104,000 miles can be found for $4,500.
If you want to be a big spender, opt for a 10-year-old Lexus or Infiniti.
A 2010 Lexus ES 300 will run about $10,000 while a similar vintage Infiniti G37 will run about $8,500.
I personally like buying luxury cars from the original owner. Usually, they drive the vehicle modestly and do the maintenance by the book. If the original owner is willing to sell their ride with 100,000 miles on it, it can be your lucky day to find a nice car at a very affordable price.
Or, if you want something newer but beefier, buy a used cop car. Police cars are sold when they are 2-3 years old with 65,000 to 100,000 miles on them. They are built to tougher standards, but they are also driven harder. However, with the savings you’ll derive, you’ll have more cash to pay for repairs as they happen.
Fortunately, I am now in a position to where I can buy a new car. However, I never have purchased a new car and hope I never will.
I will gladly let someone else take the depreciation hit and pass the savings on to me. Hopefully, you will too.