Are Cars Too Expensive?

It’s hard not to feel like a victim when the media keeps reminding us that we are being taken advantage of and pointing out the evildoers. This segment from CBS This Morning is fairly typical.

The question posed and answered was: “Can a middle-class budget buy a new American car? Probably not.” They begin with the fact that the average vehicle price increased by about 38% for a new car or truck compared to 10 years ago. Of course they don’t mention that more than half of that amount can be attributed to normal inflation. Some comes from required and optional safety improvements and some from added amenities. 

That situation will likely not improve in the future as GM just settled a six-week strike with 46,000 union members who will receive $11,000 ratification bonuses along with other contract improvements. This sets the level for negotiations with the other two US automakers. Economic understanding reminds us that those added costs will be passed along to the car buying public, but back to the story…

Armed with the average annual take-home pay and the recommended percentage for car payments, Tony Dokoupil visited a couple of New Jersey dealers to price a typical car. The only way he could meet his presumed budget was either with a 96-month loan or by buying a much smaller car.

Where is the problem according to CBS? “The big three auto-makers are retiring many family sedans while rolling out souped-up SUVs and trucks at premium rates that families often can't afford without taking on loans that are now larger and longer than ever” while “a record number of Americans fell behind on their car payments.”

About this time I’m yelling at the TV that automakers don’t make cars that don’t sell. The reason they are producing bigger cars is to meet the demand. They are not the bad guys.

To back this up I found a site from January 2019 headed: “39 Interesting Car Buying Statistics, Trends, & Analysis.” Two facts near the beginning of the list were: 

• “Passenger car sales dropped below 30% of the market share in August 2018 for the first month ever. (USA Today) 
• Sales of mid-size (15.6% decrease) and compact cars (13.6% decrease) fell in August 2018, while compact crossovers and SUV’s rose about 14.8% of the market share. (USA Today)”

That’s what people are buying.

Later in the list is the fact that the “top three features consumers are looking for in a new car are safety (21%), Bluetooth/USB connectivity (15%), and a spacious interior (11%). (Crimson Hexagon).”

Safety is number one. A reliable source provides the unsurprising information that “new small cars are safer than they've ever been, but new larger, heavier vehicles are still safer than small ones.” Not only does this explain the trend toward bigger vehicles, it also explains why the cost of cars may have risen more than inflation – even the smaller ones are safer than ever, plus customers are expecting more amenities.

Finally, Americans for a long time have had a love affair with larger vehicles. In 2016 we read: “With gas prices relatively low, you might be tempted to buy that SUV you’ve always wanted.” A few years earlier: “larger vehicles accounted for 63 percent of total US sales in 2013” and “88 percent of all pickups sold in the US in 2013 were full-size models” and 54% of the SUVs “were on the larger side.” 

A couple of other observations: the percent of budget given to Tony to spend was a range of 10-15%. In the story he used 10% for his examples resulting in a worst-case scenario. There was no mention of a down payment or trade in, but many Americans are underwater with the car they are driving, so this may be fair. But it also could be an indication of where the problem really lies. With cars and many other purchases, buying now to pay later has become normal. (See my last entry.)

Finally, in the story CBS included statements from GM and Chrysler explaining their decisions were based on a “customer-driven trend to larger vehicles” and “based on what the customer wants,” respectively. Much as it’s popular to blame the big corporations for problems, the real problem is the appetite and resulting behavior of consumers. Saving for a car before stepping on the lot and then not overspending seem to be ideas of the past.

Buy Now, Pay (or regret) Later

Usually on Black Friday I write about perspective – that any deal on electronics is not worth the life of the person trampled in the stampede. Another aspect of perspective is appreciating what we have and not constantly yearning after more or bigger or newer. The problem is that understanding the difference between wants and needs is only a first step. It must be followed by the discipline not to ignore reality by buying something anyway, especially something you can’t afford.

What seems to be catching on today is a new gimmick called point-of-sale installment loans. “This holiday season, it's not enough to spot a great Black Friday deal on a big screen TV or a sweater. You need to consider whether you want to take out a loan at the checkout, too.” 

That’s right; shoppers no longer need to go to a bank for a loan to buy something they can’t pay for. An installment loan at checkout breaks the cash register receipt into a number of easy monthly payments. That service is now available at Wal-Mart and at many other retailers, both brick-and-mortar and on line. And installment loans are expected to be “hot this holiday season, as retailers attempt to drive sales and shoppers demand easy-to-understand credit.” Retailers are partnering with finance companies to give shoppers these loans, even to people who might not qualify for regular credit cards. Instead of paying at the time of purchase, shoppers can take the items home and pay in 3, 6 or 12 monthly payments.

This is not a new idea, but was usually limited to big-ticket items. Furniture stores have used it for years. The problem is that the eventual monthly payments add up to more than the original price – sometimes 20% or 30% more. 

Not paying cash at checkout is not new either. Credit cards made that possible years ago, and both arrangements involve interest. But shoppers generally ignore the interest in light of the convenience and recognize some advantages over credit cards. Installment loans have no late payment fees, which are a big revenue source for credit card companies, and people tend to like the idea of a predictable, fixed amount each month.

It really is the same idea as a mortgage or car payment, but now the idea is moving downstream to less expensive purchases. Another source says installment plans have a “wide appeal but resonates most strongly for debit users. Four-in-ten would consider using an installment plan for everyday purchases like groceries and household items.”

An American Banker article has another explanation for the trend; “many younger Americans are uncomfortable carrying credit card balances, partly because they saw their parents struggle with debt during the financial crisis and prefer the more certain repayment terms of installment loans.”

This brings up a few issues. First, the financial problems of the parents of younger Americans were not the fault of the credit card. They were problems of discipline and perspective. Going into debt in a different way is no guarantee of success. Since installment plans have no late fee, what do they do instead, send debt collectors or repossess the sweaters and Christmas toys? (This is not addressed in any of the stories.)

In effect, this is just another marketing ploy to get people to spend money they don’t have. The example in one of the articles was of a woman who bought tires from Wal-Mart. She was all right with paying the $644 in three monthly payments of $224, but she “doesn't remember the interest rate.” (It’s about 18% APR.) In this case, tires were probably a necessity, but sweaters, purses and toys?

All this is happening while U.S. household debt, according to Motely Fool, reached $13.54 trillion earlier this year, “an amount that has risen for 18 consecutive quarters.” 

Wake up America; debt is debt! Have a happy Black Friday, but don’t do anything foolish.

Where the Money Goes

An email arrived last week in my inbox that I had trouble believing. If it had not come from a company I was already doing business with, I’d have sent it straight into the spam bin.

The email was from one of my credit card companies suggesting that I “make tax season a little brighter. Simply use your [credit card] to pay for your federal or state payments online and you’ll be rewarded.¹^,² Not only is the process fast and secure, you’ll earn valuable points you can redeem for travel, gifts and more." (Footnotes say that only some states accept credit card payment and that additional fees may apply.)

There was a time when financial advisors would urge, even beg, people to use their tax refunds to pay down their high interest credit card debt. Now we get the opposite; pay the taxes on time with the credit card, so instead of paying interest and penalties to the government for late payments, we open up the possibility of paying interest and penalties to the card company. This seemed pretty crazy until I noticed some of the other financial decisions happening across the country.

This recent USA Today piece tells a scary story. Many Americans have gotten into the habit of ignoring the total price of things they buy. If they believe they can fit the monthly payments into their budgets, they go ahead with no consideration of overall cost, including interest on the loan. 

The particular example here is car buying. In one expert’s opinion, "Easy credit and longer repayment terms have coaxed many consumers into buying more car than they can really afford," causing car debt to reach an all time high of $1.2 trillion. 

One banker remarked that his company limits auto loans to 72 months, but some competitors offer 84-month loans. That seems a little strange as the average length of car ownership hovers around 80 months. It’s more like renting a car than really owning one (and owing more than it’s worth for almost the entire time). But this mindset is to look at the monthly payment, to ignore the regularly increasing interest rates and to buy as much car as fits the budget. So people can be easily drawn to the midsize SUV rather than a midsize car with a price difference of almost $13,000, just increase the length of the loan.  Meanwhile GM is forced to close a small car assembly plant in Ohio due to fewer buyers. (Then the price of gasoline goes up, and everyone  starts complaining! Whoops, behavior has consequences.)

What most don’t realize at the time of purchase is that the car is collateral for the loan. One downturn in the economy or one temporary job loss for any other reason could mean losing the car no matter how faithfully payments were made up to that point. An example from the article tells of a 26-year-old, who lost her job at as a legal researcher and was unemployed for two months. She went into default and her 2010 Chevrolet Equinox was repossessed. That is not an isolated case. “More than 7 million Americans are now at least three months delinquent on their auto loan payments, the benchmark for many lenders to trigger a repossession.”

The behavior continues. Credit cards offer deals to help you earn “valuable” points, while banks and finance companies offer longer and longer loan durations to keep payments down (and their profits up). Everyone thinks in terms of installments rather than total cost. When the shocking news comes that you can’t buy a retirement on those same terms, it’s too late. The consequences of poor economic understanding coupled with poor critical thinking will be devastating. Everyone will be looking to the government for a bailout, a government with the same attitude of buying now and borrowing to make up the difference with no concern about the future.

IOU

When I heard that average household debt in the US was over $90,000, I went on line to find out some of the details.  I found that the $90,000 number was the amount owed spread out over all households.  Considering that about 30% are debt-free, that means only the households that are in debt owe an average of over $130,000, an even more surprising number.

This personal debt includes student loans, mortgages, credit cards and auto loans.  Now averages are tricky and summing averages does not necessarily represent reality, but such a large debt while we hear constant reports of stagnant income for the middle class is still a matter for concern.

While I was looking for the details, I ran across this article about a similar problem in Australia.  Their “household debt has skyrocketed to 185 per cent of disposable income and continues to soar.”  They blame the problem on a combination of “ill-considered public policies and lifestyle and investment choices of individual households.”  Driving these personal spending and investment choices are artificially low interest rates and other government policies and programs that discourage savings and encourage borrowing.

The article predicts that in less than five years the household debt bubble will burst leading to widespread economic hardship for those who have incurred unsustainable levels of personal debt.  As a remedy to avoid the crisis, they recommend that the Australian central bank, analogous to the Fed in the US, raise interest rates to discourage borrowing.  This will cause some short-term pain, but will avoid a likely major economic upheaval if behaviors don’t change.

This story of Australia and the urgency with which it was written made me curious about the corresponding number for the US.  I found an estimate of the household annual disposable income for the US of $41,355.  If this is, in fact, the same calculation, the average household debt in the US is not 185 per cent of disposable income – it’s almost 220 per cent!

Should we be as panicked as the Australians?  I’m not sure.  But it seems to be at least a wake-up call about personal borrowing and spending.  Overspending is a discipline issue and the consequences, whatever they are, will catch up sooner or later.

Credit Where Credit Is Due

According to this USA Today article, household debt in the US is shrinking.  “Consumers went into the recession carrying debt of nearly double the nation's gross domestic product. That's down to below 85% now, and on pace to approach 75% by late next year.”  My first reaction was, “Good for us!”  Americans are showing more discipline with their spending.  This is a good, long-term sign.  Being overextended affects our physical and mental health as well as our ability to cope with financial emergencies.  As we found out not too many years ago, when too many people take on too much risky debt, we face serious societal consequences.

The article states that this debt reduction is a good short-term sign; because when we once again get comfortable with our debt level, spending will increase, leading to more consumption, more jobs and higher economic growth beginning as early as next year.  The slow recovery in home equity is seen as the only problem.

I don’t have anything against economic recovery, but let’s not be too hasty.  First, disregard home equity.  As I have argued in the past, you will always need a place to live.  Regardless of what we hear from realtors, loan officers, investment advisors, and others who profit from the transaction, to think of home equity as an investment is self-deceptive.  Second, let's try to minimize other debt.  There are simple ways to minimize or eliminate auto loans, and people who pay off their credit cards every month are the banks’ worst nightmare.

How many times do we have to be hit over the head before we are more careful about borrowing money by delaying gratification, prioritizing wants over needs, and treating debt as an obligation or burden rather than as a convenience?  It’s only been a few years since bad borrowing decisions and pursuit of extravagance plunged us into a recession, whose negative effects still linger.

Yes, when I saw that news, I was encouraged about the potential for improved behavior in financial discipline.  I was not even discouraged by another article telling how a big chunk of the decrease in debt is attributable to defaults and foreclosures.   When the bank writes it off, the debt goes away – but comes back to haunt the rest of us as higher fees and restrictive lending policies.  (Remember, we are all connected by that economic web; there’s no magic money tree.) 

Long-term, a new sense of financial discipline can be a very good thing for America.  It will take willpower and patience, but it’s worth it to avoid the well-known consequences.  (If you still think the last recession can be blamed on banks and Wall Street, you missed this.)  And once we get our personal houses in order, perhaps we can force our government to do the same.

Down with Auto Loans!

Let’s use some critical thinking and a little easy arithmetic to improve our long-term financial situation.  The question for today is:  Why should anyone older than 45 ever need an auto loan?

Suppose you buy your first new car at the age of 25.  You have very little to put down and get a 4-year loan (by buying a car you can afford to pay off in 4 years).  Keep the car for 6 years.  For the final two years of ownership, continue to make the car payments to your own bank account.  When you are ready to buy a new car, you will have some trade-in value for the current car – probably around 40% of the original price.  You will also have a new car fund worth more than half of the original price of your first car, because you made two years of additional payments to yourself, which included interest.  Even if auto prices went up by 4% per year, you could still buy a comparable car and be able to put about 75% down – a far cry from the zero down on your first purchase.

Now you are 31 and could even afford to splurge on a car 10% more expensive.  When you put down all of that money, that car will be about 68% paid for when you drive it home.  Making exactly the same payments (not adjusted for inflation or anything) and the car will be yours in less than two years.  Keep making payments to yourself while you keep the car for 6 years. 

At age 37 when you trade your car in, you will be able to afford 88% of a new car that is again 10% better than the one you traded in (or buy a comparable model for cash).  In either case by following this same pattern, in 6 more years you will be 43 years old and be able to buy your cars for cash for the rest of your life.

Remember, those monthly car payments, mostly paid to yourself, never increased from the time you were 25.  Presumably your income has increased but the monthly cost of your car fund has remained stable and you no longer rely on auto loans.  Wouldn’t this be a great way to become more financially secure and also get back at those "greedy" bankers!  And if you are no longer 25 years old, it's not too late to start.