Over the last three years we have seen the biggest car price increases in history.
Last year the average cost of a new car in the United States was forty-seven thousand
dollars and the average used car price today is just under thirty thousand dollars.
Between January 2021 and January 2023 used car prices have gone up 52 percent while new
cars rose by almost 28 percent.
During that same period, the median household income in the United States saw a 13 percent
increase, meaning that in the past couple of years used car affordability went down
by almost 40 percent and new cars became 15 percent less affordable.
The price hikes can be traced back to the pandemic when manufacturers halted car production
due to a lack of demand during lockdown in 2020.
When economies reopened, there were shortages of important parts like semiconductors, and
factories were unable to scale up manufacturing quickly enough.
This meant that buyers who needed to buy a car over the last few years were forced to
pay at or above sticker prices for new cars.
Long waiting lists meant that people who might have preferred to buy new cars were buying
used cars to get one quickly enough, and because hardly any cars had been built in 2020, there
was a shortage of one-to-two-year-old cars, so they found themselves buying older cars
than might have wanted, and they had to pay through the nose for them.
Car buyers today aren’t just faced with higher car prices either.
Central Banks efforts to curb inflation over the last year or so have pushed the average
interest rate on a new car or truck loan to just under nine per cent in the second quarter
of 2023, up from 5.7 percent a year ago.
Lots of drivers – seeing these high prices – decided to hold on to their cars a bit
longer than they might normally do.
Just wait till prices fall a bit before buying.
For this reason, people have been keeping their old cars on the road a lot longer than
they historically have.
These older cars, that might normally have been scrapped are being patched together and
kept running.
All this extra repair work has been great for mechanics, but it’s meant that it has
become significantly more expensive to get your car fixed than it was in the past.
Mechanics get to charge a premium when things are this busy, and car parts become more expensive
when demand is high.
We’re not done yet though.
Auto insurers have found themselves losing money on underwriting car insurance policies,
and so auto insurance policy prices have been rocketing too.
Anyone who has needed to buy a car (either new or used) recently has been faced with
a perfect storm of price increases, and there has been no easy way to avoid it.
So, let’s look at why this has been happening and how things might work out going forward.
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So, in 2021 and early 2022, global shipping problems, a semiconductor shortage and factory
shutdowns collided with a rapid increase in consumer demand for cars, pushing vehicle
prices sharply higher.
It was initially believed that as auto manufacturers ramped up production and higher interest rates
kicked in that things would normalize.
Instead, prices for new cars continued to rise as automakers built fewer new cars and
focused on the most profitable luxury models, rather than the budget models where the shortage
is now greatest.
A dip in used car prices in 2022 helped to lower overall inflation that year, but used
car prices began rising again this spring as low supply encountered a new surge of demand.
The high (new and used) car prices turned out to be surprisingly sticky.
New cars in particular continued to get more expensive in 2023 as manufacturers fought
to maintain the fatter margins, they had enjoyed in 2021.
Pre pandemic, the dynamic in the auto business was that both pricing and profitability were
under constant pressure, driven by consumers shopping for discounts online.
Price comparison websites were the car dealer’s nemesis.
If you advertised a price that was too high, buyers wouldn’t turn up on the dealership
lot.
At the same time automakers were producing more cars than there was demand for and then
had to offer incentives to clear inventory.
Dealers made their profits on volume and financing, often dealing with customer complaints for
hidden charges like paperwork fees.
When customers came rushing back in 2021 to buy new cars, semiconductors needed for building
modern cars were still hard to source.
Manufacturers were also struggling with sourcing parts from China that was still enforcing
lockdowns, and Russia and Ukraine where parts like wiring looms are made.
Auto manufacturers allocated the scarce parts they could get to their highest-priced / highest
margin models — trucks and SUV’s.
They made up for the lower sales volumes with higher profits on each sale.
So, while new cars were now being built, about five million cars that normally would have
been produced never were.
The car shortage really worked for car dealers too.
They could charge well above list price — especially for the hottest new models.
As stimulus programs rolled out, and office workers were adjusting their lifestyles - now
that they could work remotely - there was more demand for new cars than supply and car
buyers were willing to pay up to get the car that they wanted.
The Bureau of Labor Statistics in the United States published a study recently that showed
that dealer markups accounted for between 35 and 62 percent of total new-vehicle consumer
inflation from 2019 to 2022.
The markups were good for dealers, even if the lower sales volume was bad, in aggregate,
the last two and a half years have been an extremely profitable period for car dealers.
The best time they have had in a long time.
Tom Barkin, the president of the Federal Reserve Bank of Richmond recently told an interviewer
that “During this two-year period, auto dealers and auto manufacturers discovered
that a low-volume, higher-price model was actually a very profitable model.”
Consumer demand is still incredibly high, and this is the case all around the world.
Britain’s used car market just recorded its strongest spring in three years, with
1.8 million cars sold between January and March this year.
There were a record 82.5 million visits to the AutoTrader website this March, 15 per
cent higher than a year earlier.
Automakers cut way back on building their cheaper models, and even low spec models of
their more expensive cars.
They rolled out electric vehicles in response to government subsidies, but even with the
subsidies, these don’t tend to be affordable to the average car buyer.
The lack of new affordable cars being built meant that consumers on a budget could only
find used cars in their price range, and of the five million cars that were never built
(the shortfall I mentioned earlier), most were affordable, or entry level vehicles.
Right now, the number of cars that would typically be available second hand after coming off
three-year leases is significantly lower than normal.
The people who leased cars right before the lockdowns are mostly buying out those leased
vehicles at the prices that were set in the lease agreement before car price inflation
kicked in.
They would be foolish to do anything else.
All of this means that the competition for the most affordable vehicles is the most intense.
People who live paycheck to paycheck whose jobs require them to turn up to work in person,
just can’t get by without transportation.
The job market has been quite strong for this group, who often work in industries like hospitality
and healthcare, so they have been paying up for used cars, as they simply have no other
choice.
Because there is so much demand for affordable transportation, there are a lot of cars on
the roads today that historically would have been scrapped by now.
Cars that you couldn’t have given away for free a few years ago are now a valuable commodity.
The average age of a car on American roads is now thirteen and a half years old which
compares to nine and a half years old a decade ago.
There are a lot of junkers available second hand, and a lot of high-end high-spec cars
available new, but not many average cars available for middle class people.
So people are spending more and more on cars.
According to TransUnion (a credit reporting agency), the average monthly payment for a
new car has risen by over $150 dollars per month to $736 dollars in the first quarter
of 2023.
Used car monthly loan payments have gone up by an average of $110 dollars to $523 dollars
over the same period.
In an economic slowdown many people could struggle to make these payments.
As interest rates have gone up lenders have started backing away from the auto loan market.
This is partially driven by the regional banking crisis that we saw earlier this year.
The falling availability of credit has been documented by the Twitter account “Car Dealership
Guy.”
Lenders are today worrying that car prices might collapse such that loan sizes become
greater than the value of the cars securing the loans and they don’t want to make any
new loans.
This is particularly the case for subprime auto loans, where buyers are paying high prices
for low quality cars.
If these cars break down, the buyers may be unable to afford to fix them, and just stop
making car payments.
High interest rates combined with only expensive vehicles being available makes for a difficult
car market.
Especially as consumers are starting to feel squeezed.
As of last month, there were over 140 thousand half ton trucks (by the top four truck makers
– Ford, Chevy, RAM and GMC) sitting on dealer lots unsold.
Many of these trucks are high spec versions - in the 60 -80 thousand dollar range – and
they have been sitting on dealers’ lots for over six months.
Dealers typically finance their inventory with what are known as floorplan loans.
Those loans – which a year ago would have been quite cheap - now have interest rates
as high as 12%, and many lenders are trying to exit that business.
Increased pressure on disposable income has been putting the consumer in tight spot.
Disposable incomes rose in 2020 and 2021 as the pandemic led to debt forbearance, stimulus
checks and better unemployment benefits.
Today as these programs are disappearing in the rear-view mirror, a lot of buyers are
beginning to default on auto loans.
According to a recent Barons article, the United States has been experiencing a surge
in vehicle repossessions.
Auto dealers are reporting repossessed vehicles going to auction where the buyer’s loan
to value or LTV ratio is over a hundred and thirty percent.
According to the Barron’s article, subprime repos have nearly doubled since 2020, to around
11% on average, and they say that the bigger red flag is in prime repossessions, where
borrowers have higher credit scores.
Apparently, prime auto loans typically have a default rate of around 2%, and today that
rate is sitting at 4%.
So what about auto insurance.
Why has it gone up so much in recent years?
Auto insurance costs 20% more today than it did in December 2021, and 70% more than it
cost a decade ago.
This is not greedflation (a term that people use for businesses stuffing through price
increases using inflation as an excuse).
Auto insurance companies are less profitable than they have been in the past.
There are not more traffic accidents either.
There are actually fewer accidents, but the average payouts are much higher per accident.
Part of this is that the cars being crashed are all more expensive to replace than in
the past.
Part of it is that repairs and replacement parts have become expensive too.
More cars are being totaled in wrecks, simply because with some new cars, replacement parts
are unavailable, and if you cant get the part, you cant fix the car.
Some EV’s and hybrids can be written off if their battery gets damaged in an accident,
as it makes up a significant percentage of the value of the car.
Finally, there has been an increase in insurance claims with attorney representation, meaning
that litigation costs have gone up for insurance companies.
So how might this work itself out?
Well, the situation may start to resolve itself soon.
Wholesale car prices have started to fall, and carmakers are beginning to offer more
incentives to buyers.
Kelley Blue Book data shows that average dealership prices in the United States have fallen below
list which signals that demand is easing.
Prices have come down in recent months for electric cars too — the fastest-growing
segment of new car sales, though a small portion of the overall car market.
EV inventories have been growing too, with most EV manufacturers building more cars than
they have been able to sell.
With the high interest rates, you might see dealerships discounting some of the expensive
cars and trucks that have been sitting on their lots unsold for months.
It is increasingly expensive for dealerships to finance unsold inventory.
Looking at stock prices you can see new car dealership stock prices are still at all-time
highs.
One reason for that is that even if consumers are struggling to afford new cars, there is
still a pent-up demand for new cars as people still need to drive to get around, and less
cars were built in recent years than are typically built.
Once the excess inventory of high-end cars is moved, maybe manufacturers will start churning
out the affordable cars that there is the most demand for right now.
It doesn’t seem likely that cars can maintain their high prices when buyers cant afford
the loan payments or the insurance costs that they are facing today.
Central banks have been raising interest rates sharply all around the world to slow demand
and cool price increases - including for cars.
Right now, that is making it very tough for consumers to afford a vehicle they might need
– either new or used.
Let me know your car buying stories in the comments section below, and how you think
this situation will resolve itself.
If you found this video interesting, you should watch my video on Tulipmania - one of the
most famous market bubbles and crashes of all time next.
Don’t forget to check out our sponsor Babbel using the link in the description below.
Have a great day and see you in the next video.
Bye.