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Auto Market Crash: A Pile Up Of Credit Disasters

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Forge Your Wealth is meant for education and entertainment and should not be used for financial advice.

We could face a less talked about financial crisis in the future: an auto market crash. This is not too unique of a financial crisis, in fact, we have faced one in many of the historic market crashes including 1929, 2008, and possibly even now.

Like any market crash, this happens by an overextension of credit for a product.

Too many people buy an item, (in this case a vehicle) using credit. Everything is fine when the economy is doing good, the borrowers can make their payments with little problem. Then the economy goes bad, suddenly those easy monthly payments are not so easy anymore. Now people are faced with a choice: sacrifice more to make those payments, or let go of their vehicle.

I will explain how and when the auto market crash will occur and how to take advantage of these deals.

How 2020 Could Cause An Auto Market Crash

What are among the largest consumer debt many people think of? Most people believe:

  • Mortgages
  • Student loan debt
  • Credit card debt

Unfortunately, auto debt is one of the worst debts. In fact, Financial Samurai ranks it as the 2nd worst type of debt. Some claim they can get a 1.9% APR. Let me put it this way. I have a credit score of 765 (excellent). When I was car shopping I was offered around 4.2% APR after some financing fees. Unfortunately, It is not unusual for a person to have an APR of 18%. That is comparable to a credit card’s APR.

So you need to pay extra for a large purchase that will at least be a few thousand dollars. And unfortunately, you normally cannot pay off the loan early. Auto loans from an auto financer charge only simple interest over a term, which generally means you cannot pay off the loan early. It is how they make money. If you pay off your auto loan early, they make less money from interest.

An Auto Loan Will Cost You

Even if you have a very low APR like mine you will still pay a good amount extra. When I was car shopping I found that there is a maximum down payment of 70% if you want a loan. That means you will need to borrow a 30% minimum. With the fees and the interest rate which contribute to the APR over a 36-month loan (smallest term and smallest APR available), the would add around 40% total to the loan. Multiple 40% with 30% (0.4 x 0.3 = 0.12 [12%]). Even in the best scenarios for an auto loan, you will have to pay 12% more than what you would if you paid with cash. I am happy I paid for a car with cash.

Many people do not know how costly the monthly payments are for an auto loan, even with the best-case scenarios. It is difficult to pay for one even when you have the maximum down payment and the best APR possible. If they cannot pay for it, they may just let it go.

Auto Loans And Amount Borrowed Have Peaked

Now the question is: how over-extended are auto loans? LendingTree’s charts below show us that the number of loans has increased.

Number of monthly auto loan originations

Source: Consumer Financial Protection Bureau

The number of auto loan originations each month has peaked at above 2 million. More people have taken out loans than ever.

On top of that, people borrow more for auto loans. Now auto loans average out at about $22,000. This could be the entire down payment for some new vehicles. Just look at the price of a new Toyota Camry.

Average auto loan size

Source: Consumer Financial Protection Bureau

Mix together a peak of the number of loans and loans where more is borrowed and you essentially have a bubble. With 0 down payments and long-term loans possible, the auto bubble sounds very much like the housing bubble of 2008 that led to the Great Recession.

The Demographics That Borrow More

Unfortunately, many buy a vehicle with a loan. In the US, 44% of Americans have at least one auto loan. More people are getting these loans and the average loan size is now over $22,000.

You could assume that everyone is getting an auto loan, but that is not the case. If you look at the chart from LendingTree the total amount owed on auto loans has increased below the age of 44.

Source: Consumer Financial Protection Bureau

These demographics include Generation Zers, Millennials (my generation), and the younger Generation Xers. These are people who either feel like they are on top of the world starting out on a new career or are well into an established career. Because of that invincibility people tend to go for newer and/or top of the line vehicles and take out larger loans in general.

I am not talking from personal experience, just from what I have seen. Older generations do not appear to be taking out nearly as many nor as large of auto loans. Ergo, most of the auto loans are seen in younger generations.

Older Generations Were Affected More

To everyone in my generation, as hard as recent events have been for us, it has been harder for older generations. First of all, they are more at risk from the virus. Second, they have had the deepest cut into jobs and income than we have. The income is not surprising, but the deeper loss of jobs is. Previous recessions usually cause a heavier loss of jobs for younger generations than older ones because younger generations could have a lack of experience and have a harder time keeping or maintaining a job. While recent unemployment certainly affected younger generations recently, older generations were more heavily hit.

There are many reasons for this including the cost of health care. Health care is primarily provided through employment for older workers and recent events led some companies to consider the costs of younger generations versus older generations. Is it less costly to train new employees who are not as demanding in compensation at least when it comes to insurance or is it less costly to keep older workers who not only need more health care but are more at risk? This is a very hard question many employers are asking.

While auto market crashes tend to occur with each recession, so does deeper unemployment with younger generations, the ones with the larger auto loans. Since unemployment is felt more with older generations, the ones with lower auto loans, the “incoming auto market crash” may not be felt as hard as it was with previous recessions.

Higher Credit Scorers Are Borrowing More

If you look at another one of LendingTree’s charts you will also see that the people making more auto loans are the people with good or excellent credit scores. This is expected because lenders tend to provide more money to borrowers with higher credit.

Auto loan monthly originations by credit score ($ Billions, seasonally adjusted)

Source: Consumer Financial Protection Bureau

Borrowers with higher credit have a history of making their payments, but that does not mean that they will always make their payments. Being a borrower is much like being a driver, you are good, but all it takes is a single instant to lose your status as “good.” All you need is a single late payment or small crash to suddenly be considered a risk.

If an auto loan borrower cannot make payments, they will lose the vehicle. The borrower can potentially reclaim your vehicle, but often the vehicle is resold at an auction or a private sale. This will increase inventory. An increase in inventory will shift the supply. However, with the decrease in credit scores due to an economic downturn many of the ways people can get a vehicle are with cash (which is in short supply).

With more vehicles in supply and smaller demand due to less income and fewer prime borrowers, an auto market crash is possible.

Interesting Aspects Of This Downturn

I know many people, probably even you, groan hearing this. This economic downturn is different. This economic downturn is the result of primarily a pandemic as compared to a more auxiliary reason for other historic economic downturns.

More People Want Safety

People are trying to social distance, which means fewer people taking public transit. Even people who are adamantly against vehicle changed their perspective. Vehicles provide safety during the pandemic versus public transportation. Furthermore, with the recent exodus from some cities, more people are seeing the value of a vehicle and the freedom they provide.

Demand for vehicles has been met in many areas, in fact, SUVs and trucks have inflated in price due to the decrease in gas prices.

This means two things. One, people may want to hold onto their vehicles more than before even if it is harder to keep up with payments. Two, people may change their minds about the vehicles they own if gas prices change again, which it likely will when demand increases.

More Desire To Save

Due to the crisis, more people are trying to save. This may mean more people are interested in buying less expensive vehicles including used vehicles versus new vehicles. It is likely a reality, new vehicle sales decreased significantly during the crisis.

What This All Means

Vehicles are not really specialty items, almost everyone can use them and the few who do not usually bum rides off others or rideshare. The pandemic probably just increased that demand, even for people who cannot really afford them. Demand should hardly decrease. Sure, maybe you do not need to drive to work, but you still need to get groceries or visit friends and family, and public transit became less of an option.

However, I would expect a crash in SUV and especially truck prices. You do not need something that size to carry groceries. Furthermore, when gas prices increase with an increase in demand people may want a more fuel-efficient vehicle.

Both fortunately and unfortunately, used vehicles are useful items. They can provide quality and affordability depending on where you look. Therefore, people almost always produce a demand for used vehicles.

Final Thoughts

An auto market crash is likely, but it probably will not be as impacting as previous auto market crashes. While an auto market bubble has formed it may not deflate too much. Unlike real estate, stocks, or bonds, vehicles are not assets, but durable consumer goods. And they are useful durable consumer goods. There are very few people who have no use for a vehicle, especially with public transit hit. However, I would expect vehicle prices to take a hit pretty broadly, but especially with trucks and SUVs.

It is possible that with this crisis, vehicle prices may decrease, but not as much as expected. Either way, the requirement for freedom provided only by a vehicle has put a financial strain on people. If you expect to get to work on time or do not want to occasionally wait five hours for a late bus to take you to your family for a weekend (which is only 48 hours it is worth mentioning), you need a vehicle.

Vehicles may be considered luxuries to some, but they are necessary for many others. Predicting the prices of cars is like predicting the price of wheat, or petroleum. There will always be demand, and as much as people try to live without them, they always find a reason to become a consumer of these goods.

How This Will Affect You Personally

However, in my experience, when shopping for a vehicle, the only thing that will ever change is the number of great deals. A vehicle that is about 20% below the market price will hardly become less expensive. These are thousands of pounds of well-engineered metals and other materials, they were not made for free so you should always expect to spend at least a few thousand on a vehicle.

Furthermore, if the supply of vehicles will increase due to increased repos, the first group to see this will be auctions and private sales, not the dealership. If you are an auction goer, you will see the effects of an auto market crash more than the typical consumer. Otherwise, an auto market crash may go unnoticed.

Author: Papa Foxtrot

Most of my life I was careful with money and learned where I should invest it. I was very lucky to have parents who taught me financial literacy when I was young. Unfortunately, I am very lucky because many people lack the financial literacy I know. The purpose of Forge Your Wealth is to teach people who are just starting out in life how to obtain their wealth or anyone who just realized they may need to learn more to handle their finances. I currently have a PhD in biochemistry, just started a job in industry (will not disclose where exactly for personal and professional reasons) and am currently married to the love of my life. I am one of the lucky few people in America who graduated with no student debts, my wife was not. Over the series of a little over 3 years we paid for our wedding with no debt and paid off her federal student loans.

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