Are you caught in a new car bubble?March 19th, 2013 by Golden Girl Finance
When we see an old car puttering down the street, we often assume the person driving it can’t afford to do better. But maybe those beater-driving beatniks have the right idea and it’s the guy in the brand-new BMW we should really be feeling sorry for? Recent statistics from CGA-Canada suggest that Canadians are financing 95 cents of every dollar they spend on a new car and using ultra-long lending terms to make it work. In other words, that guy in the BMW likely owns little more than a shiny hubcap.
But if you can make the payments, everything’s good, right? It depends on how much that new car smell is worth to you. Although cheap credit and the end of an auto-sales slowdown are making new cars more attractive than ever, what many consumers fail to realize is that being able to afford a car payment is not the same as being able to afford the car. Here’s why…
Financing fake-out If there’s one thing that’s making it possible for people to buy new cars, it’s cheap debt. With interest rates near all-time lows, car dealers are able to offer rock-bottom financing. By stretching out the length of the loan, payments all of a sudden become affordable. According to data from J.D. Power and Associates, 58 percent of Canadian vehicle purchasers now borrow with payment terms of 72 months (6 years!) or more, compared to just 14 percent in 2007.
But while buyers may feel comfortable walking off with ultra-low payments, they might be shocked if they took the time to figure out just how much more they’re paying for that sweet deal. Let’s take a look at one of the most popular new cars in 2012, the Nissan Pathfinder. Its retail price starts at around $28,000. If you finance the car at a 1.99% interest rate over seven years, you’ll pay $357 per month for the car – and more than $2,000 in interest over the life of the loan.
Stephanie Holmes-Winton, President of The Money Finder, says that financially speaking, that doesn’t fly. She suggests that those who can’t afford a payment stretched over three years can’t afford the car. Period. With this in mind, if we recalculate the monthly cost of the Pathfinder based on a three-year term, the payments climb to $800 per month. Still sound like a great deal?
Driving underwater So what’s wrong with stretching out the payments a little longer? After all, it can take decades to pay down a mortgage. That’s true, but there’s a huge and very fundamental difference between buying a home and buying a car. While a house tends to appreciate over time, a car starts depreciating the moment you drive it off the lot and continues to decline until it’s worth virtually nothing.
So let’s say you go for that Nissan Pathfinder with a seven-year loan. You’re paying $28,000 for the car, plus $2,000 in interest (i.e. $30,000 to drive it off the lot). According to Edmunds.com, it’s worth $3,200 less after a year. Once you’ve owned it for two years, it’s depreciated by nearly $6,000. After five years, it’s worth a full $12,000 less than what you initially paid for it. As time goes on, you could be stuck with a bigger car loan than what your car is even worth. This is referred to as being "underwater” and it gets its name because it’s just the kind of thing that tends to drown people in debt.
Cars and consumer culture According to 2012 data compiled by automotive research firm Polk in October 2012, each American is expected to buy over nine new cars in his or her lifetime (yes, nine new cars). That’s down from 13 cars before the recession, but assuming that you buy your first car in your 20s and drive until you’re 80, that’s a brand-new car about every six years.
Even a few years ago it was still common to see cars that were 10, 15, even 20 or more years old on the road. Now, you’d be hard-pressed to find one that was sold before 2005. So, not only are drivers paying loads of interest only to start all over again, they’re also sending solid cars to the scrap yard long before their time.
How far can a new car go? Hyundai and Kia give drivers a 100,000 mile, 10-year warranty on their cars’ powertrains. If a company can stand behind its cars for that many miles, it’s likely those cars are capable of going much, much further. And while those who often buy new cars cite repair expenses as a major sticking point, keep in mind that the repair costs on the Pathfinder would be $1,000 over the first five years, according to Edmunds.com. That’s peanuts when you’re paying more than $2,000 in interest and losing $12,000 in value over that same period.
Lessons from crashes past So what’s wrong with using cheap debt to buy something that’s more than you need and that you can afford? That would have been a great question to have asked before the U.S. housing market crash, wherein so many borrowers – and lenders – had become totally overextended. Unfortunately, everyone was too busy admiring all their new stuff to take stock of the fact that they hadn’t actually paid for it, and probably never would. Some experts are saying that same sort of bubble could be looming in the automotive market. The lesson? If you’re paying down a huge car loan, you’d better be in love with that vehicle. If the bubble bursts, you won’t be able to afford such a nice one the next time around.
When we see an old car puttering down the street, we often assume the person driving it can’t afford to do better. But maybe those beater-driving beatniks have the right idea and it’s the guy in the brand-new BMW we should really be feeling sorry for? Recent statistics from CGA-Canada suggest that Canadians are financing 95 cents of every dollar they spend on a new car and using ultra-long lending terms to make it work. In other words, that guy in the BMW likely owns little more than a shiny hubcap.
But if you can make the payments, everything’s good, right? It depends on how much that new car smell is worth to you. Although cheap credit and the end of an auto-sales slowdown are making new cars more attractive than ever, what many consumers fail to realize is that being able to afford a car payment is not the same as being able to afford the car. Here’s why…
Financing fake-out If there’s one thing that’s making it possible for people to buy new cars, it’s cheap debt. With interest rates near all-time lows, car dealers are able to offer rock-bottom financing. By stretching out the length of the loan, payments all of a sudden become affordable. According to data from J.D. Power and Associates, 58 percent of Canadian vehicle purchasers now borrow with payment terms of 72 months (6 years!) or more, compared to just 14 percent in 2007.
But while buyers may feel comfortable walking off with ultra-low payments, they might be shocked if they took the time to figure out just how much more they’re paying for that sweet deal. Let’s take a look at one of the most popular new cars in 2012, the Nissan Pathfinder. Its retail price starts at around $28,000. If you finance the car at a 1.99% interest rate over seven years, you’ll pay $357 per month for the car – and more than $2,000 in interest over the life of the loan.
Stephanie Holmes-Winton, President of The Money Finder, says that financially speaking, that doesn’t fly. She suggests that those who can’t afford a payment stretched over three years can’t afford the car. Period. With this in mind, if we recalculate the monthly cost of the Pathfinder based on a three-year term, the payments climb to $800 per month. Still sound like a great deal?
Driving underwater So what’s wrong with stretching out the payments a little longer? After all, it can take decades to pay down a mortgage. That’s true, but there’s a huge and very fundamental difference between buying a home and buying a car. While a house tends to appreciate over time, a car starts depreciating the moment you drive it off the lot and continues to decline until it’s worth virtually nothing.
So let’s say you go for that Nissan Pathfinder with a seven-year loan. You’re paying $28,000 for the car, plus $2,000 in interest (i.e. $30,000 to drive it off the lot). According to Edmunds.com, it’s worth $3,200 less after a year. Once you’ve owned it for two years, it’s depreciated by nearly $6,000. After five years, it’s worth a full $12,000 less than what you initially paid for it. As time goes on, you could be stuck with a bigger car loan than what your car is even worth. This is referred to as being "underwater” and it gets its name because it’s just the kind of thing that tends to drown people in debt.
Cars and consumer culture According to 2012 data compiled by automotive research firm Polk in October 2012, each American is expected to buy over nine new cars in his or her lifetime (yes, nine new cars). That’s down from 13 cars before the recession, but assuming that you buy your first car in your 20s and drive until you’re 80, that’s a brand-new car about every six years.
Even a few years ago it was still common to see cars that were 10, 15, even 20 or more years old on the road. Now, you’d be hard-pressed to find one that was sold before 2005. So, not only are drivers paying loads of interest only to start all over again, they’re also sending solid cars to the scrap yard long before their time.
How far can a new car go? Hyundai and Kia give drivers a 100,000 mile, 10-year warranty on their cars’ powertrains. If a company can stand behind its cars for that many miles, it’s likely those cars are capable of going much, much further. And while those who often buy new cars cite repair expenses as a major sticking point, keep in mind that the repair costs on the Pathfinder would be $1,000 over the first five years, according to Edmunds.com. That’s peanuts when you’re paying more than $2,000 in interest and losing $12,000 in value over that same period.
Lessons from crashes past So what’s wrong with using cheap debt to buy something that’s more than you need and that you can afford? That would have been a great question to have asked before the U.S. housing market crash, wherein so many borrowers – and lenders – had become totally overextended. Unfortunately, everyone was too busy admiring all their new stuff to take stock of the fact that they hadn’t actually paid for it, and probably never would. Some experts are saying that same sort of bubble could be looming in the automotive market. The lesson? If you’re paying down a huge car loan, you’d better be in love with that vehicle. If the bubble bursts, you won’t be able to afford such a nice one the next time around.