How is it possible that every three years a couple can go out and buy a new car and yet their payment never seems to go higher? Haven’t cars gone up in price?

The magic is in the length of the credit offered and the movement of not buying the new car but leasing instead. The length of automotive loans has gone from three years to four years to five years and now even to ten years. But if a couple is turning their cars every three years what is happening to their debt/equity?

Let’s run some basic logic through this issue:

Basic Numbers:
Average Miles Per Year: 12000
Average Loan Length (1990): 3
Average Loan Length (2004): 5

In 1990 a couple would have complete equity in their car when they turned it over to buy a new one after three years of ownership.

In 2004 a couple would have about 60% equity in their trade in at three years turn.

In 1990 a couple would have paid about five percent on their automotive loan.

In 2004 a couple would pay about three percent on their automotive loan.

From 1990 to 2004 an average car has increased in price by more than 30 percent. The least expensive cars now are at the $10,000.00 price point where in 1990 they were closer to $7,000.00.


































In 2004 the fastest growing portion in automotive sales is the pre-owned category. National and regional pre-owned dealerships are now commonplace where in 1990 they were just starting to see the future potentials for pre-owned chains.

So with the cost of cars up and the income of the couple not up at the same level, there was only two things that a manufacturer could do to turn more vehicles. Lower the interest rate through promotion and increase the term of the loan to keep the payment for the couple’s car in the same ballpark as it has been prior.

The couple does not notice much past the monthly payment so when the term is extended they won’t see a price increase on themselves until it comes time to trade it in three years from now.

When they go to do their normal trade in at three years they notice that they have less equity in their car than before when they traded in on a new car. But they have been paying the same amount each month for the same amount of time as prior, why shouldn’t they have the same equity? This is simple, it is because the car costs more and the loan was longer than before.

And what about the first time buyer…

In 1990, while it was a stretch for a new driver to buy a new mini truck or compact car, it was still attainable on a part time income while going to school. Now, a first time buyer will have to look at pre-owned vehicles for the most part and be working full time to be able to afford a monthly payment, insurance and upkeep. Throw that on top of the largest increases in history on the price of a college education, housing, food, books, etc. and you have a formula for economic disaster.

So can this trend continue? Yes. As long as we continue to allow the length of the loans to get longer and are accepting of the lack of equity at trade in time. Focusing only on the monthly payment.

Can a car loan exceed that of a basic twelve year mortgage? Yes, with the skyrocketing costs of real estate the twelve year loan is less and less the term of choice opting for the thirty year more often than not now. So in the consumer’s eyes we have just started to reach the 1/3 mark on auto loans to real estate loans.

Can cars continue to increase in average price till they are the same price as a single family home in the Midwest? Sadly, yes. The upper end of the average car price is currently that of a small home in the Midwest and the trend will continue.

Can consumers continue to go more and more negative on equity in their cars with each turn? Yes, consumers that wish to maintain a specific monthly payment will continue to go more and more upside down in their new cars with each trade in.

How can this trend be corrected if the prices of cars continue to go up and the lengths of car loans continue to extend? In a booming economy the answer is simple; keep the length of the loan the same as the prior purchase. But in today’s economic drought the best answer is to downsize the vehicle or look at pre-owned as a primary choice. By reducing the cost of the vehicle and maintaining the length of the loan as your prior purchase you will be able to increase your equity at the end of a cycle while maintaining or even reducing your monthly outlay. Remember though, you will be paying more interest on a pre-owned vehicle as the manufacturer promotions for reduced or even zero percent loans normally do not apply to pre-owned cars.

When the pre-owned market out paces the new market the manufacturers will see their way clear to bring back value to their lineup rather than more and more creative financing and cash-back promotions.

Oh! All of the above is based on a good credit rating. If you are anything less than an A you can expect to pay much more in the cost of the loan and be expected to increase your down payment as well. And if that does not put you into your car of choice at the price you want per month then expect to hear the “lease” pitch from the finance manager.

The most important person at any car dealership these days is the F&I person or Finance Manager. Their job is extremely focused and only one result is acceptable, roll the car. A common sign to see at dealers both new and pre-owned is “We can finance anyone”. What this means is that they have a buyer for all kinds of paper. From A rated to extreme credit risk. The way that they make this possible is to make the paper more saleable by decreasing equity risk on the paper buyer. This is done by increasing the amount of down payment as well as increasing the percentage rate paid on the loan. With that in mind it is easy to see how dealers can finance anyone. Bad credit? Bankruptcy?....no problem! Just give more cash upfront and pay more per month in interest and someone will be waiting to buy the paper.

So let’s say that our couple was an A on their last car purchase but over the past three years they have seen some hard times that cost them a level or two on their credit rating. Not only are they going to lose equity level on their trade in due to their five year loan and trading in at three, but also they are going to be asked to come up with more money up front and pay a higher rate on their new loan interest wise. Compound that with a higher vehicle cost and you have a need for a much higher down payment to maintain their current cost per month on their new car.

So in reality an A rated consumer is losing equity and making payments longer at a slightly reduced APR but anything outside an A is not only losing equity but they are also increasing cash down payments and paying higher interest rates on the loans.

While Finance Managers are doing their jobs to the best of their ability the consumer continues to ask for more each visit to the dealership. This combined with the manufacturers need to increase the number of units rolled each year makes for a downward trend in true consumer ownership. The day of the possessor holding the pink slip is slipping away more and more.

High credit card debt, consumers taking inflated equity out of their homes and less and less automotive equity makes us the most debt ridden generation ever. Compound that with social security cuts, corporate matched IRA’s falling by the wayside and unemployment at its highest numbers in decades makes this a time that consumers need to be conservative in spending as well as what they accept as personal debt.

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