Why I’m sitting out the car market until 2H 2023

October 29, 2022November 3, 2022 ryan.renkey

It’s been a minute since either my wife, or I bought a car. I’ve had my hatchback since I moved to Wisconsin 5.5 years ago and decided that a rear-wheel-drive sports coupe was a bad fit for snowy Midwest winters while my wife has had her car since she went to college. Amazingly, our cars are in terrific shape for their age due to the relatively low number of miles we’ve put on them. However, our life is completely different today. Back in 2017 we hadn’t even moved in together. Today, we have both a toddler and a dog and would love to welcome another little one into our family. What we really want is a minivan.

For years I vowed that we’d never need a minivan. They’re as expensive as a large SUV, drive like a boat, and are the symbol of boring practicality. When my wife and I welcomed our baby girl into the world that narrative began to shift. Each time we pile into my Mazda3 Hatchback I’m reminded of how much stuff a tiny human requires. Fitting a family of three in my car works okay for now but as we consider adding a second child to our growing family a minivan is increasingly appealing. The question for us is no longer if we will buy a minivan but when. Given the current backdrop of prices as well as our own financial situation here’s a few reasons why I think we’re better off waiting until this time next year.

Car prices are at historic highs

For 25 years leading up to the pandemic, car prices increased modestly over time. While inflation did slowly drive up the price of both used and new vehicles the price increases were almost imperceptible from one year to the next. We can see this in the graph below which shows Manheim’s used vehicle value index from 1995 to today. At the far-left hand side of the graph the prices in 1995 are indexed to a value of 100. Prior to vehicle prices surging in 2020 the index is at a value of approximately 140 which represents a 1.35% compound annual growth rate. With overall inflation measuring about 2% over that same time it’s no surprise that a measly 1.35% growth rate seemed to fade into the background.

However, after the initial Covid lockdowns in March the index shows a rapid appreciation in vehicle prices as demand for used vehicles accelerated. One of the primary factors at play in the price spike was supply chain issues especially chip shortages that disrupted the production of new vehicles. With new vehicles affected by supply chain shortages, demand shifted to the next best alternative: used cars. Today, prices for both used and new autos remains elevated which means today’s consumers are getting less for their money than they would have perhaps at any point in their lifetime.

Supply chain pressures might be easing

While auto prices remain elevated around historic highs, prices have begun to trend downwards quite rapidly. In the Manheim Vehicle Value Index, the speed of price declines in used vehicles mirrors the pace of rapid increases that we saw begin in 2020. If the price declines perfectly mirror the earlier price rise, then we can expect that the vehicle market will take about 18 months from its peak in January 2022 to reach pre-pandemic levels. This would mean that we should expect better vehicle pricing for buyers in the second half of 2023.

Unfortunately, waiting means that the car that we sell or trade in will sell for less if this trend continues and I’m ok with that. Even though we’ll make less on the sale of our vehicle, we can expect that the drop in sale price of our minivan will more than make up for the lower sale price of our 11-year-old SUV. Since the car we’re buying is more expensive than the one we are selling we are net buyers in the car market and benefit from lower prices. For example, let’s say our SUV is worth $8000 today and we’re shopping for a $40,000. If we were to make that purchase today, then we would need to come up with $32,000 (40,000-8,000) to complete the purchase. If we instead decide to wait and prices of all vehicles drop by 10% then our SUV is now worth $7,200. However, since all vehicles dropped in value the minivan that we intend to purchase now costs only $36,000. The minivan’s price drop more than offsets the drop in value for our SUV. Instead of finding $32,000 we only need to come up with $28,800 when prices drop.

Interest rates have surged

The Federal Reserve has raised interest rates at its fastest pace in decades. Many of the headlines on interest rates have focused on mortgage rates but the Fed’s rate hikes have an effect on interest rates across the economy, including auto loans. These higher rates have a real and very significant effect on the purchase price when you finance an auto purchase. Just a year ago there were many advertised rates for car loans around 3% or lower. Today with the Fed’s rate hikes the market interest rate for many buyers with excellent credit is 7% or more.

Using the same hypothetical $40,000 minivan with a 20% down payment of $8,000 we can calculate how much more expensive it is to finance a car today compared to a year ago. Using a common auto loan length of 60 months, a $32,000 loan at 3% interest will cost about $2,500 in interest. A loan for the same amount at 7% will cost about $6,000 in interest over those same 60 months. Unless you’re paying in cash then the same exact vehicle now costs several thousand dollars more to purchase today. I don’t know exactly where rates will go in the next year but waiting will give my family an opportunity to save more for a down payment and be less affected by the higher borrowing costs.

Credit, leverage, and other personal factors

Everyone has a different financial situation and different family needs that will influence what decision is best for you. In my particular case, here are a few of the additional factors that are pushing me to wait longer for a new vehicle.

Credit Score – My credit is typically stellar. However, my family closed on our house less than a year ago for a house that stretched our budget a bit at a little over 4x our annual gross income. My credit is still recovering from this additional credit line. It will probably take several more months to get to a score that would qualify me for the best available rates.
Financial Leverage – Back in Wisconsin we had a mortgage of about $190k on a house worth $340k for a loan to value (LTV) ratio of 55%. This is a relatively low amount of leverage relative to our new LTV ratio of 15%. Having a higher leverage ratio can help us generate larger returns on real estate appreciation but it also means we’re taking on more risk. Waiting helps to reduce our financial risk as we slowly pay down the balance of our mortgage through our regular monthly payments.
Family Needs – As a family of three we do not need a minivan today. The sliding doors could make loading and unloading easier, but we’re not capacity limited based on our current family size. Both vehicles can accommodate 5 passengers, and each has under 100,000 miles. Given our current needs, buying a new vehicle for more space would be a large luxury purchase.
Higher Expected Income – As a current graduate student, I stand to make significantly more next year than I made this year. A higher income makes a large purchase easier to afford and could be a factor for many people in their 20s and 30s who expect to make more.

Readers, are there any factors I haven’t considered that would lead me to purchase a car sooner rather than later?