Summary
- Interest rates on loans are rising sharply, as are insurance rates
- Inflation is causing this rise, as the economy is still recovering from the latest major hit, the Global Pandemic
- Gas prices, interest rates, insurance rates, and more are all combining to cause an aggregate effect of sales slowing down and dropping
- This effect is felt mostly in urban areas, but only two markets are fighting to keep up with projected growth: Compact cars and SUVs
- We think that the only way these rates will come down is with the Federal Government and Automotive Industry cooperating to lower overall spending, increase subsidization of supply, and possible implement a temporary tax to recover the economy.
There are a lot of considerations that go into a new or used vehicle purchase. You need to budget for the monthly payments as well as your insurance, factor in gas, maintenance, have a little set aside for emergency roadside service if you need it, and the like.
Now, to just add to the headache, even as car prices are finally starting to drop again, loan rates are skyrocketing. What is causing this increase, and how is it affecting the automotive new and used market?
The Base Cause: Inflation
Just 25 years ago, if you watched a car ad on TV, you could get 0% interest on financing on approved credit. Even if you credit was a little lackluster, 3.5% was commonly offered, with those with horrid credit often getting 8% or 9%. The key factor here is that all of those rates are single digit.
The North American economy has taken two massive blows in the past 25 years with the 2008 market crash and then the 2020 to 2022 global pandemic. The bounce back from both of those events, tied in with a gradual increase in household income, have caused the Federal Reserve to increase the average money supply, meaning inflation.
On top of that, parts and production costs have also risen, adding to that inflation. The reason that we are focusing so much on the cause of inflation is that interest rates on new and used car loans have skyrocketed in the past 12 months.
In Q1 2023, the average rate for a six-year new car loan with good credit was 6.97%. This year in Q1, the average was 8.41%, nearly 1.5% in just one year… and that’s with good credit. It’s even worse for used loans, as they were hovering around 10.1% in Q1 2023, and hit 14.52% in Q1 2024!
It’s also not just contained to loans. Since the parts for repairs have gone up, insurance rates have had their most significant jump in nearly four decades, rising 22.6% between April 2023 and April 2024, according to the US Bureau of Labor Statistics.
To break it all down into numbers, the average buyer of your typical midsize family sedan can be paying in excess of $10,000 over the six-year lifetime of their loan. In 2022, that number was closer to $6,500.
Add on top of that potentially thousands of extra dollars spent just to insure those vehicles, and there is a dark shadow hovering over the automotive market during the peak buying season, Q2 and Q3.
The Aggregate Effect: Sales Are Down
With the real median household income in 2022 at $74,580 according to Census.gov, and your average midsize family sedan at approximately $30,000, one can begin to see the effects.
First of all, you need to add another $10k on top of that average price, bringing it to $40,000, albeit spread over 72 months.
Add on insurance as well, which in 2023 put you back about $200 per month if you had no accidents and collision and comprehensive riders. In 2024, that same insurance now costs $245. Yearly, that is $2,400 rising to $2,940.
Let us not also forget about the necessary evil that is gas. Thankfully, most average vehicles operate on 87 octane, so there is a small bit of relief there.
However, in May 2024, the average price per US gallon across the USA was $3.706. Go back even one year, to May 2023, and it was $3.445. Add in that most midsize sedans have a tank of about 16.5 US gallons, and you fill it twice a month.
That isn’t even taking into consideration maintenance, oil, filters, winter tires and rims, wiper blades… you get the point, which is that all of this piles up rather quickly.
The average total price of a midsize sedan on a six year loan would come out to somewhere around $66,445, over twice the actual MSRP of the car.
The net aggregate effect is that automotive sales are down almost entirely across the board. There are a few outliers, such as Toyota’s Camry gaining a modest 4% month-over-month sales increase from April to May 2024, but in general, sales are within 1% of previous months, and in many cases, are dipping towards the negative.
Take the historically successful Honda Accord, for example. In Q1, it rose from 12,025 units in January to 15,785 units in March, an increase of 31.2%. The moment Q2 hit with the increased interest rates and more expensive overall purchase? Immediately drops to 12,403 unites in March, with a very small recovery of just over 11% to 13,794.
In fact, the only two areas of the market that have posted something even approaching the growth estimate of 15% sales quarter to quarter so far have been compact cars and midsize SUVs. Cars such as the Honda Civic, Toyota Corolla, Acura MDX, and Lincoln MKX have all posted growth Q1 to cumulative Q2 in the 13% to 16% range.
What Happens Now?
For someone living in a mostly rural area, this is bit of a double whammy, as they rely on their vehicles to get into the city or for supply runs. This can also be translated to those living in the suburbs, although some public transit or ride sharing exists to defray those costs some.
It is the urban population, which is most of the US population as it stands, that are causing the sales drop. On top of expensive rent or high property taxes, owning a vehicle becomes something of an outright luxury instead of a necessity. With the Federal Reserve rates still climbing, it’s starting to form a perfect storm of financial woes.
We think that the only real way around this current crisis is for both automakers and the government to put their heads together. Fiscal policy with reduced spending and temporary increases in taxes is one of the most surefire ways to stabilize inflation. For the automakers, getting some relief on supply and production costs would defray a lot of the interest rate hikes, as it would allow the MSRP to drop enough to absorb the hike.
Of course, this solution exists in a perfect world where there is an economy of excess and those willing to buy. The reality is that for many urban populations, public transit, ride sharing, and micromobility are becoming the norm instead of the exception, and that means, quite simply, that they aren’t spending on cars.
