Car Tips for Buying a Discounted Car Soon

The information presented in today’s post is nothing new; however even though it has been around for a while, the implications may never have been discussed openly.  This information will give you several car tips so that you may have an edge for buying a car in the coming months.

Today we are going to cover those implications and revelations currently unfolding in the car market.

First of all, if you are planning on buying a car (new or used) in the short term future, STOP!  I highly encourage you to read the remainder of today’s post and understand what this will mean for you as a car buyer if you exhibit some patience to allow the current scenario in the car buying market to play out.

An article appeared in USA Today on March 4 of this year talking about the car buying market.  In this article, there are some startling facts about the car buying market:

• Average interest rate for car loans is 4.56%
• Average amount to borrow for a car is $28,381
• Average car loan length is 5.5 years (66 months) 

As we saw in our last post on car value, cars tend to lose their value quite swiftly over the life of the car.  We also saw that some new cars can lose as much as 50% of their value within the first two years of ownership.

This is setting up for an interesting scenario in the car market.

First of all, let us assume that the $28,381 is only the amount borrowed to purchase the car.  Not the amount that will be paid back (with interest).  By taking this number and multiplying by 1.277 (1.0456^5.5) we get the value of the loan to be paid back.  1.0456 is just the growth of the value borrowed at the length of the average loan 5.5 years (don’t worry if you don’t understand the math portion, the end results are the most important).

By multiplying this we get the value of the total loan being $36,269 (28,381*1.277); the buyer is already losing out from the get go because they are paying $36,269 to get something worth $28,381.  Shows how a down payment up front can go a long way in lowering your overall cost of ownership.

By dividing the total cost of ownership by the months (66) we get $550 (36,269/66) which is the monthly payment for the car.

Now, we can look at how much the car will be worth after every year and compare it to the value left to be paid on the loan.  For this example I randomly chose the Ford Mustang and the Toyota Prius since these car’s new price is close to the $28,381 average borrowing noted above.

I am assuming that the car buyer in my scenario is going to be driving the car at the U.S. national average (13,476 miles per year) in order to determine the value year over year.  Also, I chose the "Very Good" designation from Kelly Blue Book since that designation would probably be a more accurate value of a trade-in.  I also used the sell to a dealer price for the value because if a buyer wanted to get rid of the car and payments were still owed to the dealership, then this would be the main option for the buyer to get rid of the car - sell it back to the dealer. 

During the first three years of this fictional average loan, the buyer is considered underwater (the value of the loan is greater than the current value of the car).  This is a risky time for the creditor (dealerships) of this loan because if the buyer feels they cannot make the payments, then there is little incentive for them to keep paying the loan if the value of the car won’t exceed the value of the loan until sometime in year 4.

This makes the default risk of these loans to be quite high.  On top of that, here is a sample of some of the advertisements used to generate these loans.

 

Remember everything I said about the risk?  That risk just went higher because it looks like all types of credit scores are able to borrow large amounts of money to finance their car purchases.  Meaning that people who have a credit score that says they may not be able to repay loans are getting boatloads of money to buy cars (and no guarantee of repayment).

 

The last time that this happened was in 2008, except it was in the housing market, not the car market.  Much like then, the potential outcome this has on the market is that many car loans will be defaulted on and cars will be returned to the dealership from which they came.

How does this affect you?  I am glad you asked.

If the used cars return to the dealers, the market supply of used cars will increase rapidly.  By implementing basic economics we can see what this will do to the price of used cars.

The supply of new cars will dramatically increase the supply of used cars and this increase will cause the price of used cars to be lowered as dealerships will need to make room on their lots to have newer cars in there.  More cars will have to be sold quickly and the best way to ensure this is to lower the prices of those cars.

However, if the used car prices go down this could make buying a new car less attractive since buying a used car is drastically cheaper.  This could also affect the new car prices by sending them lower as well if this scenario plays out as outlined above.  Fewer people will demand a new car and the way to sell the new cars is to lower the price as well.

Bottom line:  if you are in the car buying market, the recent events in the car market may make it worth your while to wait to buy your new or used car.  For those of you wondering what the answer is to the question title of this post, the answer is have patience.

To Your Success,