The cost of buying a new car in the US has reached unprecedented levels as interest rates on loans have soared to the highest point since 2007, according to a report by Edmunds, a car research group. The average monthly payment for financing a new car hit $736 in March 2023, while nearly one in five buyers owed at least $1,000 a month.
Rising interest rates squeeze car buyers
The main factor behind the rising car loan payments is the increase in interest rates, which averaged 7% in the third quarter of 2023, up from 4.5% a year ago. The higher rates reflect the tightening of credit conditions amid the economic recovery from the pandemic and the inflationary pressures caused by supply chain disruptions and labor shortages.
The higher interest rates mean that car buyers have to pay more in interest over the life of their loans, which can add up to thousands of dollars. For example, a buyer who financed a $35,000 car at 4.5% interest for 60 months in March 2022 would pay $3,968 in interest, while a buyer who financed the same car at 7% interest for the same term in March 2023 would pay $6,483 in interest.
High car prices add to the burden
Another factor that contributes to the high car loan payments is the elevated price of new cars, which has been driven by strong demand and limited supply. The average transaction price for a new car was $41,950 in March 2023, up 9.4% from a year ago, according to Kelley Blue Book.
The high car prices are partly due to the global shortage of semiconductors, which has forced many automakers to cut production and reduce inventory. The chip shortage has also affected the availability of popular models and features, such as advanced safety and entertainment systems, which tend to have higher profit margins for automakers and dealers.
The high car prices have also been influenced by the shift in consumer preference toward larger and more expensive vehicles, such as crossovers, SUVs and pickup trucks, which account for nearly three-quarters of the new car market. These vehicles offer more space, comfort and performance than sedans and hatchbacks, but they also consume more fuel and emit more emissions.
Car buyers resort to longer loan terms
To cope with the high car loan payments, many car buyers have opted for longer loan terms, which lower the monthly payment but increase the total interest paid. The average loan term for a new car was 72.9 months in March 2023, up from 69.6 months a year ago, according to Edmunds. Nearly a third of new car loans had terms of 84 months or longer, compared to less than a quarter a year ago.
However, longer loan terms also pose risks for car buyers, such as negative equity and higher depreciation. Negative equity occurs when the amount owed on a loan exceeds the value of the car, which can make it difficult to trade in or sell the car without paying extra money. Depreciation is the loss of value that occurs as a car ages and wears out, which can reduce the resale value and increase the maintenance costs.
Car buyers face affordability challenges
The combination of high interest rates, high car prices and long loan terms has made buying a new car unaffordable for many Americans. According to Edmunds, only 18% of households could afford to buy an average-priced new vehicle in March 2023, down from 23% a year ago. The affordability gap is even wider for low-income households, who may have limited access to credit or savings.
As a result, some car buyers have turned to alternative options, such as leasing, buying used cars or postponing their purchases until conditions improve. Leasing allows car buyers to pay lower monthly payments and drive newer models without owning them, but it also limits their mileage and customization options. Buying used cars can offer lower prices and lower depreciation rates than buying new cars, but it also involves higher risks of mechanical problems and warranty issues. Postponing purchases can help car buyers save money and wait for better deals, but it also means driving older and less reliable vehicles.