The Four Wheeled Bubble

Bubbles are always obvious … in retrospect.

Here’s one you might not see coming.

The Car Bubble.

People are taking out eight-year car loans.

This is — or ought to be — alarming. The automotive equivalent of the zero-down, no-doc, adjustable rate mortgage on a $500,000 McMansion circa 2004.

You know — just before the housing bubble popped.

New car loans used to be 36 months (three years) and then 48 months (four years). Back when the economy was sane.

Today, the typical new car loan is 72 months (six years). This is almost double the formerly typical length of a new car loan.

But even that is not — apparently — enough to keep the music playing.

Enter the eight-year loan.

Which might be ok, if cars were not appliances.

Very expensive toasters, basically.

Though modern cars are longer-lived than the cars of the past, they are — like any other appliance — something you eventually throw away because eventually, it will wear out. Or cost too much to fix — relative to the value of the car itself.

This is why cars always decline in value over time. It is the nature of the thing.

With an eight-year loan, the odds are high that it will begin to wear out — and cost you money to fix –before you’ve paid the thing off.

Then you’ll have a car payment and repair payments.

On a car that’s not worth very much anymore.

Are people stupid?

Desperate?

Or, on dope?

Actually, they are on credit — and debt.

Just like before.

Stretching out the loan from four to six (and now eight) years is a way to make a car you can’t afford seem affordable. To hide from view just how much a new car really costs.

Consider:

The average price paid for a new car this year was about $35k, a record high.

The year prior, it was $33k.

But the average family income in the United States is around $55k. And it has been around $55k for at least a decade.

People are buying more car — with less money.

Sound familiar?

It ought to be obvious that the $55k family cannot afford a $25k car. Even a $15k car is a financial stretch given a $55k pre-tax income.

Some quick math:

A four year loan on $25k at about 3 percent interest works out to a monthly payment of about $555. How many families living on $55k can afford a $555 monthly car payment? (Don’t forget the taxes, the tags and insurance. Plus the gas. So really — conservatively — about $700 a month.)

The answer, Alex, is — not many.

Enter humbug financing.

The six-year loan.

Now the payment is “only” $380 — which seems more manageable. But it is a fantasy.

Eventually, the bill is presented.

Because an eight-year loan is a guaranteed loser. Worse, arguably, than the no-doc, zero-down, adjustable rate house loan… because at least the house is a place to live in; has more than transitory value.

It is not merely an appliance. Not disposable by design.

Unlike a car, a house will usually still be worth something a decade after you bought it. You might not make Monopoly money on the thing. But if you bought in at a reasonable price, you will probably not lose Monopoly money, either.

In this way, a house is still a traditional way to “store” money. It is realistic to think you will at least get out of it what you put into it.

With cars, this is almost impossible.

Even if you do not use the car. Which of course defeats the purpose of owning the car. It would be like buying a house and then not living in it.

A car’s value lies chiefly in the fact that it can be used for transportation. If it is not used, it is functionally worthless. But if you use it, inevitably, its value decreases as the miles accrue and the years go by. Eventually — after about a decade — it will be worth perhaps a fourth of what it cost you to buy new.

This is called depreciation —  and she is heartless.

Most cars lose about 20 percent of their purchase price value before two years have elapsed. Five years marks the Event Horizon for the majority — the point at which their retail value has slipped to about half what they were worth when new.

At 72 months — six years out — the typical new car is already close to being under water, if it was financed. Push that loan out to 96 months (eight years) and it is all-but-certain you’ll be gargling seawater.

Which, if it affected just those who bought beyond their means, would be unfortunate but economically just.

Unfortunately, this bubble, like the housing bubble, will affect all of us when it pops.

And, before it pops.

Humbug car financing has caused car prices (like home prices, pre-bursting bubble) to rise generally — for everyone.

It is almost impossible to find a new car without an LCD touchscreen, 17 inch “rims,” a fancy stereo and (of course) AC, power windows, locks and cruise control. These have become almost givens.

The problem is, they’re not being given away.

Now add in all the stuff that’s not on the sticker — but which still pads the bottom line. Or did you think six air bags (and all the rest of it) was a freebie bestowed by the car companies because they care so very much about your safety? They — the car companies — are just middle men, really. The government decrees — the car companies build — and we pay.

All of us.

Including those of us who’d choose — if we could — to skip the six air bags and the LCD touchscreen, too. Because we’d rather live within our means than live with perpetual (and ever-rising) debt.

Eventually, the music will stop — and some people are going to find themselves without a chair to sit down on.

Comments?

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3 Responses to “The Four Wheeled Bubble”

  1. Brother John says:

    I worked briefly in a car dealership early in 2001 (worst job I ever had, no question); at the time, I was astonished to see six year/72 month financing emerging. I had never heard of such a thing. That explains part of the ridiculous price of cars in the last 15, 20 years or so; the dollar being aggressively trashed by the federal government’s runaway spending explains some more …. what else is there?!

  2. Ken in NH says:

    What’s more is that people who use these terms sometimes do so thinking they will pay it off faster and save interest by making extra principal payments each month. Even if they have the discipline to do so, unlike home mortgages, car financing companies make it difficult to make extra payment to the principal each month.

  3. Al says:

    If you need more than a 4 year loan, you can’t afford it. You need to learn to buy within your means. I will never buy a car I need to take more than a 3 year loan on.