New Car

You Probably Cannot Afford a New Car, But You Will Buy Anyway

Statistically, most Americans cannot afford to buy a new car. Yet sales figures show that we are doing so anyway. What gives? Are we approaching an automotive bubble?

Owning a car is part of the American Dream. Owning a brand new car is a sign that you've "made it" financially and is, for many people, almost on par with home ownership in terms of economic importance. Yet statistics show that if sound financial advice were followed, most Americans cannot actually afford to buy a new car.

Wait! What? But new car sales are at record highs, so there must be a lot of people buying new cars. Right?

Yes, there are. This doesn't mean they can necessarily afford them. A lot of people were buying houses in 2006 and 2007. Doesn't mean they could afford them either. Is the current purchasing trend in automotive indicative of a new financial bubble that will collapse markets? By itself, probably not. As a trend on the whole? Perhaps. That's for economists to debate. For now, let's just talk about cars.

The average new car in 2013 sold for about $32,000 off the lot. This means that the average purchase price for all cars sold in 2013 was about $32,000, so there were some that were far more expensive and some that were far cheaper. If you consider the most popular vehicles in the U.S. last year, the Toyota Camry and the Ford F-150, you'll understand why this average cost was what it was. According to (a subsidiary of Bankrate), that price tag is above, often far above, what most households can actually afford to pay for a car.

In most of the cities surveyed of the 25 major metropolitan areas on the Car Affordability Study list, only one had an income high enough to justify a $32,000 car purchase. Only three, including that one, had the new vehicle price within 20 percent of what the median income household in that city could afford. That means that in 22 cities around the nation, most people cannot actually afford the average new car.

Yet the bulk of car sales are not in low-end, entry-level, low-priced vehicles. The term "median" implies that they're in the $32,000 range instead. In some areas, median income was so low that people in cities like Tampa can afford only a small handful of the new car models on the market today - and then they would be buying at base level.

So what is "affordable?" The metric was the standard rule of thumb often referred to as the "20/4/10" rule. This is the rule often cited by financial advisers as the basic way to calculate what you can afford in an automobile. You put 20 percent down, get a four-year loan, and pay no more than 10 percent of your monthly income for payment and insurance on the vehicle. calculated that to be about $641 for a $32,000 car.

Curious as to whether this rule was too conservative, I asked around. One friend of mine, an accountant, replied that he advises clients not to get a loan on a car at all, but instead to always pay cash for vehicles. Why? "Interest rarely meets depreciation and debt is not a good idea in our current economy." Another CPA told me that his general rule is a 20/5/10, which merely changes the above rule to a 5-year loan period rather than four. He says that since most auto loans are had at rates under 4 percent, this is justifiable if the down payment can knock out the immediate "off the lot" depreciation right away - which 20 percent will do on a large portion of new car purchases.

Finally, I asked a financial adviser. He gave me the 20/4/10 rule, but with caveats. He only recommends that for those who cannot afford to purchase outright, are under age 45, and who would retain the ability to still save or invest at least 10-15 percent of their income. He also recommends avoiding the "brand loyalty" stigma of only buying one or two kinds of car because they are theoretically "more reliable" and instead purchasing based on financing offers and maintenance and warranty inclusions. "A car with a reputation for reliability is great, but one that comes with a guarantee of reliability and 2% financing is better."

This is sound financial advice coming from not only one of the most-trusted Internet brands for financial advice, but also from at least two more people who work in the business of personal finances. Yet most Americans are, apparently, ignoring this advice and buying more than they can afford when they purchase an automobile.

Here's how many of them are getting away with it. First, many are not buying under 4 or even 5 year loan options, but are instead paying for out to seven years. Making payments on a seven year old car seems ludicrous on its face, but for many, it pulls that monthly payment down to within the 10 percent goal of our rule of thumb. Another point is interest itself. Many manufacturers offer very low interest rates to qualified buyers. Lower interest means higher principal payments which, in turn, means a higher principal (car price) can be paid. On a five-year loan, an interest rate of two percent can mean a couple of thousand or more saved on the total cost of the car when the loan is closed.

And the most likely reason that many are buying cars they cannot technically afford? Leasing and by cutting into other life costs. Leasing is generally a cheap way to get into a vehicle that otherwise is not likely affordable and delaying the cost of that car, perhaps indefinitely if the lease-drive-lease paradigm continues. On top of that, the savings rate in this country is very, very low. Since the 1980s, personal savings rates in the United States have nose-dived, hitting an all-time low in 2004 at just 1.5 percent of total disposable income and currently trending at around 3.7 percent. In the 1980s, personal savings trended around 11 percent of total disposable income, fell to that low, then went up to about 5 percent in 2008 before the market crash. Likewise, median net worth fell in parallel to savings drops. This shows that the current trend is to spend rather than save, accounting for the likely higher percentage of personal income being spent on an automobile.

What do you think? Are Americans spending too much on cars? Should people be re-thinking their lifestyle choices in terms of personal finances and automobiles? Or is the financial advice given by these experts out of touch with reality?

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If your commute is 60 miles a day or less and your spending more than $250 a month in gas, you can get a brand new car for free. Leases on new Nissan Leafs start out at around $200 a month. Electricity is about 1/6-1/10th the cost of gas. $250 a month in a 20 mpg car = $25 a month in electricity. Doesn't get much more affordable than net-free.
I do agree that spend versus save is at an all time low. The thing is - and the appropriate financial advice USUALLY is - to rent the things that depreciate in value and purchase things that appreciate in value. That's where leasing a vehicle comes into play - you lease the car so that you're never really taking the depreciation hit. Americans as a rule have a 3 - 5 year trade cycle, so in that case, actually buying ANY vehicle doesn't make a lot of sense. BUT - there are two caveats to this. The first has to do with either paying cash or making large down payments, and that's due to manufacturer incentive rates. If you've a manufacturer that's offering 0% interest for 4 years - then simply purchase the car with little to no down payment. You've the money in the bank to purchase the car anyway - so effectively you're getting the use of your money that you intended to spend and you can invest the difference yourself. The second caveat is if you go into the deal planning on keeping the car for more than 10 years from the very outset. Some cars are, let's face it, disposable. Very few people purchase a Kia Soul planning on keeping it 10 years. Even 'sexy' cars like Mini's have very low owner loyalty. But you get people keeping a Toyota, Honda, or Subaru for literally decades. THOSE cars, it makes perfect sense to spend a little more, get a few more amenities in the first place, because you INTEND to keep that car for a long time.
I like the LEAF and all, but how does someone commute under 60 miles per day and spend $250+ on gas? You'd have to have a real guzzler (20mpg or less at 60/day) and at that point, the person's car is obviously not as small as a LEAF so they're very unlikely to downgrade in size to one.
You don't magically ignore the depreciation when you lease a vehicle, though. They include that in the lease terms and payments. Leasing also has other caveats that make it less than desirable for many (probably most) buyers. I have a friend who leased a Chevrolet Volt and is now well beyond her lease terms and will have to pay dearly for that when it comes up in a few months. She plans to buy out the vehicle rather than pay penalties and trade it.
It's a funny country and world. I own two rental condos that cost less than a Tesla. The families that live there have included a mechanical engineer, an accountant, and a senior sales and marketing person at a medical device maker. All responsible people with solid employment. Yet they live in a home they rent, that costs less than a Tesla P85. I have interviewed Tesla owners who always want to make clear to me that "they are not rich." Two Americas. Then there is the reality than one can drive a nice family car like a Sentra or Corolla for about what many spend on their cable/internet package. I liked this story.
How long did they live there, though, John? Renting has decided benefits for those with busy lifestyles or short-term contracts. Renting means that there is no obligation, cost (time or money), etc. involved in keeping the home and no hassle when you need to leave it behind. Ask Tim Esterdahl how simple it was to drop his house in the Denver area, in a highly sell-able neighborhood, and move. It took months. We own our home because we plan to live here a while and knew that from the time we moved in. Were I still a truck driver, however, and had I planned to continue doing that once we bought the house, I would not have purchased and would have rented instead. Why? Because I wouldn't be home to do the maintenance and work on the house and would prefer to leave that to someone else so my time at home would be quality instead.
I think my post was poorly written and caused misunderstanding. I think my tenants are making a wise choice. Renting is economically smart right now for many. I meant to convey that there are people living in good, decent homes that cost less than cars. The folks that lived in the units I bought had been there for more than a decade (both). Many people pay too much for cars. Others pretend that leasing is somehow better.
I have always wondered. When a family applies for college financial aid does the form require them to say what they drive? If they have owned new cars over the past 10 or 15 years, or any sort of premium vehicle, is the financial aid form thrown directly into the trash? If not, why?
Good question.
God informative read! Well done Aaron, thanks...
Thanks, Parks.
Being an auto enthusiast can be another reason to buy a new vehicle. I bought a 2012 Toyota RAV4 V6 because it was the last year for the V6 and I don't want a 4-cylinder or a turbo charged anything. A finance rate of .49% helped – especially since I'm earning 1% on the money I'd have used to pay cash.
Of course, current inflation is 1.6%, officially..
Loved the article. I agree so much with this. I cannot understand how people find a way to afford these new cars. I wish I could. As a family of six we have owned a different suv for nearly 20 years. It seems the bigger your need the more out of price range it is. I believe that car companys and dealers are getting fat on the average persons greed. You know they are making ridiculous profits per each vehicle sold when then can build such egregious builings, constant commercials, their heating and electric bills must be otherworldly yet its worth their profit margin. If the american people would get themselves under control and stop buying new, we would see a revolution in new car prices.
every single person i know buys new cars. what a waste of monthly income. My husband and I saved for our truck 10 years ago like 4 months or something straight, saved 8K and bought our truck we drive now, 1996 7.3L F350. Before that I saved for all my vehicles save for 1 i bought on time, it was such a nightmare i never bought on time again. We are good with our truck and have put lots into its upkeep, but we had it because we dont have car payment overhead nightmare like our friends do. I have 1 friend who just bought a BRAND NEW toyota truck THAT GETS 12MPG what a sap! Before he bought this piecer, I told him " save. buy cash. buy a mid 80's Toyota 4 runner V6 30-40 mpg". He said "i want it now and i dont want to wait!" i have other friends they buy on time as well, and cant afford to. I guess we are a dying breed of savers. In fact no one wants to save for anything these days, they are renting underwear. its pitiful.