The 84 Month Event Horizon

The duration of the average new vehicle loan has gone from three or four years to six years over the past 40 years, which when you think about it is a much better way to gauge the effects of what’s styled “inflation” than using the usual method of adjusting what a dollar buys today vs. what a dollar bought in the past. That method implies that the cost of things hasn’t really gone up; we’re just paying more dollars for things.

The hair in that soup is most of us have fewer dollars relative to what things cost. Put another way, things (most thing) really do cost more. Cars are a prime example. If it were just “inflation,” new car loans would still be three-or-four-years long, as they typically were back in the ’80s – when the average price paid for a new cars was about $7,500. But it isn’t just “inflation,” as testified to by the government’s own inflation calculator. That $7,500 – which bought an average new car back in 1980 – is about $20,000 dollars shy of the number of dollars it takes to buy an average new vehicle today (about $52,000). That’s why it takes six years to pay off the loan. More accurately, it’s why it is necessary to stretch out the payments for six years, in order to make the monthly payments affordable. A $52,000 purchase factored over five years will cost you about $850 per month to pay off. This assumes zero interest, by the way – so in actuality, the payment would be considerably higher. If you extend the loan by another 12 months, you can get those monthly payments down to about $700. This is the way the finance guy at the dealership makes an otherwise unaffordable new car “affordable.”

Of course, you’re still paying more. It just feels like a little less.

So now the solution – the bigger Band Aid, to cover up the larger wound – is to push loans out to seven years (84 months). This may sound like a not-bad idea. Home loans are routinely 30 (and even 40) years long long, which is necessary because lots of people cannot deal with the payments on a $400,000 loan (the average cost of an average new home) factored out over just 15 years. Put another way, it is the only way most people can afford a home. So why not extend the average new vehicle loan out to seven rather than six years? Why not eight years – or even longer? A new vehicle that goes for $52,000 would be a lot more affordable if that cost were factored out over a decade rather than six years.

Well, the problem is that a vehicle – unlike a house – rapidly loses value. On average, whatever it is you buy today will be worth less than half what you paid for it by the time you make that final payment on the six year loan you took out. Usually, whatever you paid for your house, it will be worth substantially more than whatever you paid for it by the time it’s paid off. That’s why a home is generally considered an investment while a new car isn’t. (Car salesman often use the word “investment” when trying to sell a new car, but it’s something like the way the COVID shots were sold as “vaccines.”)

It’s actually a liability – from the standpoint of a lender.

A $52,000 car financed for seven years probably won’t be worth half what it sold for after five years. But the monthly payments doe the remainder of the loan are still based on what the car sold for when it was new. This serves as an incentive for the person who took out the loan to stop making payments once they are under water.

Dumping the car and cutting one’s losses seems cheaper than continuing to make payments. The car is then repossessed and re-sold (and re-financed, probably). But it will probably have to be sold/financed at whatever its depreciated value is. The balance due on the original loan will have to be written off, which doesn’t mean no one pays for it. The financing shylocks will get their pound of flesh, one way or another. Regardless, the take-home point here is that loans beyond six years are fundamentally untenable. The implication is that $52k-plus average new car transaction prices are also untenable. Something is going to break. Something is already breaking. You can hear the cracking sounds portending what’s going to happens sooner or later.

Probably sooner rather than later.

When it does happen, expect probably a third (maybe half) of the car brands currently selling cars to go bankrupt. This happened back in ’08. It is going to happen again – only it’s probably going to be deeper and harder this time, when it does. Why? Because the government hasn’t got the money to “bail out” the foundering car companies; it could just print more, of course. Or it could tax more. But that will only exacerbate the problem of most Americans having fewer dollars to buy things that cost more dollars.

A way out of this percolating shit-storm would be to remove all the regulatory barriers that make it impossible to import and sell new cars that cost $15k or less (such as the $10,000 Mazda Flair I wrote about recently). Cars like that could be financed over three years – or even bought outright, cash on the table. There would no longer be any worries about being under water – holding the bag (the loan balance) on a massively depreciated $52k car that’s only worth $25k when you’re still making $700 per month payments on the thing.

Trump could make it so – he (like He Man) has the power. But he hasn’t – and probably won’t. Which makes you wonder why.

. . .

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