Will Higher Prices and Rising Interest Rates Dampen Auto Recovery?

Despite the relatively weak job market and stagnant wages, consumers are opting to buy more expensive vehicles with more options and upgraded features, and taking on more debt to do so.

Now some industry experts fear that higher transaction prices, coupled with higher interest rates may prevent a full recovery for the auto industry by putting new vehicles out of the reach of many consumers.

The average price of a new vehicle has climbed 12 percent since 2008, requiring consumers to take out longer-term loans. Wages during the same period have actually slipped by 0.05 percent when adjusted for inflation.  National Automobile Dealers Association president Peter Welch fears that the combination of slipping wages and higher prices could “dramatically affect sales.”  In a recent interview, Welch said, “Being able to put people into cars is going to be a real challenge.”

Most economists, however, expect interest rates to remain relatively flat over the short term. During the second quarter, the interest rate on new car loans averaged just 4.5 percent, compared with 6.4 percent in 2008.

Many also claim that pent-up demand for new vehicles will help sustain sales. They also point to the recovery in the housing sector for increases in sales of light pickup trucks.

Many consumers are also turning to leases in order to afford new vehicles, attracted in part by residual values that have risen steadily in recent years.  During the first half of the year, leasing accounted for 26 percent of all U.S. vehicle sales.

Delinquencies and repossessions are also down. During the second quarter, only 0.36 percent of auto loans resulted in repossessions, and delinquencies of 60 days or more accounted for only 0.58 percent of all U.S. auto loans.

Still, the data suggests that consumers are being stretched thin by higher levels of debt. Consumer borrowing for new vehicle purchases has risen steadily. Average borrowing for new car loans reached $26,526 during the second quarter, up 12 percent from the same period five years ago. Because of lower interest rates, however, the average monthly payment of $457 was actually $13 lower than in the same period in 2008.

Experian’s senior director of automotive credit Melinda Zabritski says, “We’ve all become used to having these extremely low rates.” She predicts that automakers will use incentives to offset any increases in interest rates. She also expects to see longer loan terms in the near future. The average term now stands at a record-high 60 months.  Loans with terms of 73 to 84 months already account for 19.5 of all new vehicle loans.

Jim Stutzman is the owner of Jim Stutzman Chevrolet-Cadillac in Winchester, Virginia.  He says his customers don’t appear to be fazed by today’s higher prices and lower incentives.  According to Stutzman, “Ten years ago we were offering cookie-cutter, plain Jane cars with no pizazz. There was nothing there for people to say ‘Wow, I really have to have this car.’ It was always ‘How much will you give me off?’  Now that they see the value equation, they don’t have a problem paying more.”

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