New car buyers face a major affordability problem as both car prices and interest rates rise quickly. This could put buyers at risk of slipping into negative equity on their new vehicles
According to recent research 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.
- More than 15% of consumers who financed a car in Q4 2022 committed to auto loan payments of more than $1,000 a month.
- That’s a record high, and a significant increase on last year.
- High vehicle prices and elevated interest rates make it a very expensive time to buy a new car, and put new car buyers at risk of negative equity.
New Car Prices and Interest Rates Are Increasing
According to the data released by Edmunds, just over 15% of consumers who financed 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 also represents a rapid increase in the cost of car loans – just one year ago, 10% of consumers committed to such a large payment.
There are two main reasons for the increased cost of car loans. One is simply that new cars are more expensive than ever. According to an estimate by J.D. Power and LMC Automotive, the average cost of a new car in December 2022 was $46,382. That’s also a record high, and an increase of 2.5% over the course of last year.
The second factor affecting new car buyers is the base interest rate on new car loans. The average interest rate on these loans is now 6.5%, up from 4.1% a year ago. Auto loan lenders have raised their interest rates as the Federal Reserve has. Worryingly, things could get even worse – as the Fed increases interest rates to combat inflation, the cost of a car loan could get even higher.
New Car Buyers Face Negative Equity Risks
Increased car prices and interest rates may have increased the cost of car loans, but that doesn’t mean that paying more than $1,000 a month for a new car make sense. Indeed, consumers who take out costly car loans today may face significant financial risks.
Though 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 come down in the next few years, as microchip shortages caused by the Covid-19 pandemic subside and more new cars are available. This, in turn, is likely to cause a decline in the value of used cars.
This means that consumers who finance a new car today are likely to see their vehicle decrease in value relatively quickly, even while they are paying a high interest rate for the loan they used to buy 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 may make financial sense to do so.