Today’s topics:

• 💣 Is the American consumer about to break?

• 🔧 Shoppers Corner: Can I finance an extended warranty?

• 🎤 Podcast Transcript with Jonathan Smoke, Chief Economist of Cox Automotive: Vehicle Shortages Explained, Car Price Predictions & more…

Reading time: ~3 min

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💣 Is the American consumer about to break?

Vehicle supply has been growing steadily and rising new car sales have followed. High interest rates and elevated prices have done little to stop the pent-up demand that resulted from nearly 3 years of inventory shortages.

However, I now see several economic indicators that are likely to cool down demand and present potential challenges for manufacturers and dealerships.

First, consumers continue to focus their spending on health, personal care, food & beverages, while reducing spending on durable goods.

Spending is largely driven by savings. Pandemic-time stimulus packages allowed Americans to accumulate considerable excess savings (the ones above the usual trend). Invictus research estimates that excess savings were over $2 trillion and contributed to the highest inflation in 40+ years.

However, personal savings are now over 85% off their peak level. With less savings, it is no longer a question of “if” but when consumer demand will contract.

Note that the majority of savings are concentrated in the top two income quartiles. More affluent consumers, who are responsible for the majority of spending, still have healthy savings. Lower-quartile earners will be facing more pressure and will have to pull back on their spending.

That’s why car manufacturers lately have been focused on lower volume but higher margin vehicles that capture dollars from those who can afford them.

Consumers stop spending not when they should, but when they have to. Federal Reserve data shows that consumer debt has been growing for all income quartiles except for the top one. Inflated prices for all everyday purchases are forcing consumers to dip into savings (which are gone by now) or rely on debt. 

The lower two income quartiles are responsible for 92% of the total consumer debt. This means that 1) It will be hard for these consumers to access credit and 2) Delinquencies will increase, translating into higher losses for lenders.

This is confirmed by consultant Bill Ploog’s analysis of 10-Q statements from major auto lenders that show increases in auto gross losses.

Today’s auto market is a reflection of the imbalance between income segments. Wealthy buyers are able to deal with higher interest rates or simply pay cash. There is plenty of inventory to choose from in traditional domestic and EV categories.

At the same time, the competition is heating up on the low end. People who work in healthcare, hospitality, construction, etc. have to drive to work, but they can’t find affordable cars because a) manufacturers have not been building cheaper cars b) lease returns are dry.

There’s also a segment of consumers sitting on the sidelines waiting for prices to fall.

Let’s not forget about the second-order effects of softening demand and declining prices. According to J.D. Power estimates, 24 million consumers purchased their cars at “elevated” prices. When car prices will start softening so will the equity positions of consumers, who will end up being disproportionately underwater on their loans and leases. This means they won’t be able to easily flip their cars and will fall out of the market, amplifying the shortage of quality used cars.

We have two opposing forces acting on used car prices: softening demand and further tightening of supply.

The situation may take some time to resolve itself. Manufacturers are producing more new cars and are offering more incentives, but it will take a few years for these cars to reach the used car market.

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🔧 Shoppers Corner: Can I finance an extended warranty?

Car loans usually come with some stipulations. For example, a minimum required down payment, the vehicle age and mileage not exceeding a certain threshold, proof of income, minimum credit score, and others.

One of the stipulations is LTV (or loan-to-value ratio) which connects the amount of money you borrow with the car's value. For example: If you take out a $25,000 car loan to buy a $30,000 car, your loan-to-value ratio would be 83%.

When you are underwater on your trade-in, the LTV may exceed 100% because you are rolling the negative equity of the current loan into the loan for the car you are buying. By limiting the LTV, lenders are protecting themselves from risk in case they have to repossess and sell the car.

When car prices are elevated, there are cases when you may not qualify for a loan because the LTV is too simply too high. You have to come up with a higher down payment or find another vehicle.

If you are pushing the LTV limit, you cannot include any additional products into the loan. However, in some cases, you may want to consider an extended warranty or a service contract offered by the dealership.

So now there are companies who offer financing for these additional products sold by dealerships. For example, there’s a company called Sunbit that would finance add-ins, such as extended warranties, service contracts, gap insurance, key replacement, exterior and interior protection, etc [Disclaimer: this is not a sponsored post]. The financing is offered at zero percent interest to shoppers. Instead, the company makes money by charging a fee to the dealership. This allows consumers to still add a valuable extended warranty to the purchase even when hitting the LTV limit for the car loan.

Should you get that warranty? I just spoke to a service advisor at an independent repair shop. He just got a brand new Chevy truck and despite having access to parts at labor at his shop, he still purchased an extended warranty that extends way past the standard manufacturer's warranty.

He said that he strongly recommends all of his customers to get an extended warranty, even for newer vehicles. Given the labor rates and the cost of parts, one major repair can justify the cost of the warranty in many cases.

Should you finance that warranty though? Depends on your financial situation.

🎤 Podcast Transcript with Jonathan Smoke, Chief Economist of Cox Automotive.

Vehicle Shortages Explained, Car Price Predictions & more…

Listen to the podcast (52 min) or Read the full transcript 

• (00:51) Our unique market environment

• (04:12) Jonathan's background

• (08:45) The Great Digitization

• (11:46) That time CDG bought 50 Chevys at auction

• (13:40) Are we in a K-shaped recovery?

• (18:45) Domestic vs International supply constraints

• (26:00) When do we get back to 2019 price levels?

• (33:45) Forecasting new vs used car prices

• (38:19) Advising a new car buyer

• (41:42) Jonathan's take on EVs

• (47:38) DJ Smoke's recommended listening

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