A while back Jalopnik solicited reader stories about really bad automotive loan deals. If you haven’t yet read the story and its comment thread, they are worth a quick look — if you can stomach it (Streeter, 2021).
Some folks get into trouble partly because they lack financial literacy. They may not understand the basic mechanics of a loan. Just as importantly, they may not know how to think strategically about achieving their long-term financial goals.
Also see ‘Financial illiteracy among car buyers is ‘staggering’
This isn’t surprising. Auto sales can be juiced by people who make impulse buys. Cars are still an important way of displaying what Thorstein Veblen (1994) called “conspicuous consumption” — even if it means going deeper into debt. The buff media tend to enable this by talking up Detroit’s latest wares rather than educating their readers on automotive finance.
I was thus impressed when I came across a website seven years ago — interest.com — that helped people make better car-buying decisions. Although I criticized the methodology of a report that this website published on the affordability of new cars, interest.com did offer some useful advice (go here).
Younger generations push car debt to a record level
Unfortunately, interest.com appears to have been transformed into a different kind of business. So where else might one find decent advice? Financial expert Dave Ramsey (2021) recommends that one should buy a used car and pay in cash. He walks through the math of that approach compared to buying an average-priced new car on credit. In one scenario, you could save enough money to buy a $20,000 car in three years.
This is not terribly popular advice. Auto loans account for 85 percent of new-car purchases and 53 percent of used-car purchases, making them the third-largest form of debt (Lexington Law, 2021). In 2020 the total balance of automotive loans grew to a record $1.37 trillion, with younger generations showing the biggest increases, according to Experian data. The average car loan balance in 2020 was $19,865, up 6 percent from 10 years ago (Stolba, 2021).
Also see ‘Why younger people are keeping their vehicles longer’
Racking up auto debt can suck away money that could have been used to achieve other long-term goals, such as buying a house or building a retirement nest egg.
That said, Renee Valdez (2021) lists circumstances where one might be better off taking out a car loan rather than paying in cash, such as when building one’s credit rating. And sometimes used-car prices for a given model may be so high that the right loan terms could make a new car more compelling.
Car credit has become more popular since the 1950s
The proportion of car buyers who take out car loans has increased since the 1950s, when one third still paid in cash. New York Times reporter Micheline Maynard (2007) noted that these “customers, many with lingering memories of the Great Depression, came to showrooms with their check books or stacks of bills.”
Maynard (2007) noted that those who decide to pay cash may get a “frosty dealer response” — and a “concerted effort to get them to change their minds.” She quoted a former car salesman who stated, “When I was at a closing and the customer said, ‘this is a cash deal,’ I knew I would not make any money for the next hour.”
Share your reactions to this post with a comment below or a note to the editor.
RE:SOURCES
- Lexington Law; 2021. “Study: how are Americans buying cars?” Posted April 22.
- Maynard, Micheline; 2007. “On Paying for Cars With Cash.” The New York Times. Posted July 28.
- Ramsey, Dave; 2021. “Should I Buy a New or Used Car?” Ramsey Solutions. Posted Aug. 3.
- Stolba, Stefan Lembo; 2021. “U.S. Auto Debt Grows to Record High Despite Pandemic.” Experian. Posted April 12.
- Streeter, Mercedes; 2021. “What Is The Worst Car Loan You’ve Ever Seen?” Jalopnik. Posted Aug. 4.
- Valdez, Renee; 2021. “Buying a Car with Cash: Everything You Need to Know.” Autotrader. Posted Jan. 29.
- Veblen Thorstein; 1994. The Theory of the Leisure Class. Penguin Books.
Extended loan terms to get people to buy a more expensive vehicle are nothing new. Buick used this tactic in 1954-55 through GMAC to get people into a Buick (generally a Special or Century) instead of one of the low-price three. Of course, that ultimately came back to bite Buick, as it borrowed sales from the future (people were taking longer to pay off their loans, which kept them out of the market), and dimmed the luster of its prestige. If lots of people can afford something, it really isn’t all that special. Part of the appeal of upscale goods is their exclusivity.
Auto makers – particularly GM, Ford and Stellantis – are using longer loan terms to move big pick-ups and SUVs (and Jeeps and Broncos), many of which have nosebleed prices (at least, to me). Home equity loans have fueled this trend, too. But those vehicles are their main profit makers.
I wonder if we are heading for a great “reset,” where people will have to downsize their vehicle choices, which means that the companies are going to have to take some drastic measures to stay in business. (A decline in housing prices could trigger this, too, as people can’t withdraw equity from their homes if it’s not there in the first place.)
I’m sure that Ford still wants to sell Escapes and Edges, but there is no denying that those vehicles don’t bring in as much profit as F-150s and Expeditions. Something will have to give.
I have also wondered whether we are headed for a great reset — somewhat akin to the first oil embargo in 1973. In addition to the escalating cost of purchasing big pickups and SUVs, gas prices could start to really pinch. All of a sudden smaller and more economical cars could become popular. Maybe even wildly popular.
If that occurs, what will the automakers do who dumped their smaller passenger cars?
During the last run-up in prices, the main long-term movement was from larger SUVs to smaller ones. The compact SUV segment grew, and it is now very important. The Honda CR-V, for example, has been the brand’s best-selling vehicle.
Most likely buyers will move from an Expedition or Explorer to an Escape or Bronco Sport. Ford’s new Maverick is already a hit…the main problem has been building enough of them to satisfy customer demand. Escalating gas prices most likely will mean that next year’s production will be sold out, too.
It will be interesting to see how things go. The EPA says the Ford Maverick gets 37 mpg, which sounds pretty good. However, this is hardly a small and light vehicle, e.g., its base curb weight is over 3,500 pounds for the FWD EcoBoost model.
The Maverick has room for four people, can carry some loads in its bed, and is big enough not to be blown around by tractor trailers on the highway. For most buyers, it is practical and substantial enough to serve as their main vehicle – while still returning decent gas mileage.
A real problem for Ford in the current market is that the EcoSport is barely competitive with the current Honda HR-V, and Honda is getting ready to unveil an all-new one. That is a weak point for Ford.