According to a recent survey released by Edmunds, an auto industry analysis firm, more new car buyers than ever before are paying more than $1,000 a month on their auto loans.
New car buyers face a major affordability problem as both car prices and interest rates rise rapidly. This could put buyers at risk of slipping into negative equity on their new vehicles.
- More than 15% of consumers who financed a car in the fourth quarter of 2022 committed to making auto loan payments of more than $1,000 per month.
- This is a record and significant increase compared to last year.
- High vehicle prices and elevated interest rates make buying a new car very expensive and put new car buyers at risk of negative equity.
New car prices and interest rates are rising
According to data released by Edmunds, just over 15% of consumers financing a new vehicle in the fourth quarter of 2022 committed to a monthly payment of more than $1,000. That’s a record high, and it also represents a sharp rise in the cost of auto loans – just a year ago, 10% of consumers committed to such a large payment.
There are two main reasons for the increase in car loan costs. One thing is simple, new cars are more expensive than ever. According to estimates by JD Power and LMC Automotive, the average price of a new car in December 2022 was $46,382. It is also a record and an increase of 2.5% compared to last year.
Another factor influencing new car buyers is the prime interest rate on new car loans. The average interest rate on these loans is now 6.5 percent, compared to 4.1 percent a year ago. Auto lenders raised their interest rates as did the Federal Reserve. Worryingly, things could get worse – as the Fed raises interest rates to fight inflation, the cost of a car loan could get even higher.
New car buyers face downside equity risks
Rising car prices and interest rates may have increased the cost of car loans, but that doesn’t mean paying more than $1,000 a month for a new car makes sense. Indeed, consumers who take out expensive car loans today can face significant financial risks.
Although new car prices have risen significantly over the past year, there is no certainty that this trend will continue. Indeed, there is good reason to believe that new car prices may even fall over the next few years as microchip shortages caused by the Covid-19 pandemic subside and more new cars become available. This in turn is likely to cause used car values to drop.
This means that consumers financing a new car today are likely to see the value of their vehicle depreciate relatively quickly, even as they pay high interest on the loan they used to purchase it. This puts these buyers at significant risk of negative equity – that is, a situation where they owe more on their loan than their car is worth.
If you really need to replace your vehicle, you may have no choice but to take that risk. But if you can wait to finance a new car, it might make financial sense.