While I dream about owning a Nissan GTR that I saw at the Chicago auto show, in reality I drive an old Nissan Altima about 10 years old. That damn car will run forever since I take decent care of it and my frugal nature won’t let me replace it without a valid reason.
As I drive around in my older car, however, I can’t help noticing all of the expensive cars out on the street. Right now it is Saturday night here in Chicago in River North, and lots of people are “cruising” up and down the major streets, seeing and being seen, in their tricked out cars.
The situation is the same even when I visit a poorer neighborhood. A relative of mine moved to Beverly, in the south side of the city, and no matter how you drive to get there, you need to go through some pretty rough neighborhoods. New and expensive cars are ubiquitous, even there.
Let’s think a bit about car economics. If you use $25,000 / loan at 48 months as a starting price point, and the average rate of 6.5%, you are paying about $600 / month.
However, that “minimum payment” model has gone belly up. Here’s why.
Car manufacturers have gotten out of the 1) car loan business 2) car leasing business. In order for them to finance the loan, they need to guess what the resale value of the car will be at the end of the lease, as well as the likelihood of the owner defaulting (they can repossess the car but this is an added expense and it comes with the risk of the car being trashed along the way). They also need to have the cash available to make the loan, and pay interest on this entire amount of the cash, until it is paid back. The asset backed securitization model that let them push the risk onto outside investors has essentially seized up in the credit crunch, so they can’t unload these items off their balance sheet.
The car dealers and their financing arm look like lousy credit risks, so it is getting difficult for them to raise money, that they would in turn use to loan out to customers. Chrysler stopped leasing cars in August 2008. GM (through their financing arm GMAC) stopped financing (for sale or lease) customers with a credit score below 700. This article also mentions the fact that Ford is getting out of truck leases, and has an example of someone who leased a 2006 car costing $35,000 for under $200 / month (see how BUYING a $25,000 car costs $600 / month up above).
When it comes down to it, over 50% of Americans have a negative net worth, meaning that loaning them any money for anything is likely to be a losing proposition long term. The car companies have to put a lot of money into a $25,000 car and then they turn that into a string of payments to someone who doesn’t have much equity in their home or savings and they are pretty much just betting that person will continue to make payments AND that the car’s resale value won’t fall off a cliff.
What would you say if someone who had little in the way of savings and tangible assets, and who was burdened with heavy home debts, asked you for thousands of dollars to finance a car loan? You need to raise that money, and pay interest on the money, as well as take the risk on the car repossession and resale values years out, to someone who can’t even come up with much of a minimum payment.
The model is dead. Leasing is gone, and car loans to dodgy buyers are going the way of the dodo.
If you want a car, and you don’t have a lot of money, then you will need to put a big down payment of your own money on a used car more in line with your financial limits – which means a $2000 – $5000 car. When you go into those neighborhoods, or even nicer suburban neighborhoods, you will see many less shiny new cars out and about, because people can’t come up with the sales price and financing is fading away.
Even Mercedes and BMW will eventually feel it… while there are a lot of wealthy people, if they actually have to come up with the cash to purchase those $50,000 / or more cars, sales will plummet. With leasing deals limited, the customer will need to pony up a lot of cash to drive one of those cars off the lot.
I looked at the Chicago Tribune ads this weekend:
– GM, Chrysler and Ford all talked about the “total” car price, less incentives
– Toyota and Nissan still talked in terms of monthly payments, along with Audi and BMW
Part of the reason that Toyota, Honda & Nissan can still discuss monthly payments is the fact that their cars depreciate much slower than the US models. For instance, a Caddy will lose about 50% of its value in just 2-3 years, while the equivalent decline in value for a Honda, for example, will be far less.
With the easy financing gone, let’s all just re-evaluate our love affair with new and flashy cars. Beyond basic transportation and safety features, cars are viewed as a sign of economic virility or personal expression. But we can’t afford this anymore, and there is no one to finance this type of turnover (buying / leasing a new car every few years).
Paying interest on something that is rapidly depreciating is madness; in homes we are seeing a giant version of the same sucking sound (paying interest on an asset declining in value) with a corresponding wrenching impact on the economy; but the same thing happens each time you drive a car off the lot, especially when it is full of features beyond the basics.
In a way, we are back to square zero. Growing up, my family always bought used cars, as did most everyone I knew. Only a few of our wealthier acquaintances would buy new cars, and even fewer would do so every few years. Leasing, low interest rates and asset securitization allowed many Americans the (foolish) option of buying new cars, but now this option is receding into the distance.
This month the major US automakers posted huge declines against prior year sales, up to 40%. This shock was partially due to the fact that the economy went off a cliff, but another major element was the absence of low cost financing. Among all the other problems for car makers, add this to the list, and it is likely to be the bullet that finally takes them down, unless they are substantially rescued by the US government.
Cross posted at LITGM