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Why are Car Prices so High?

Finance | 08/29/2021 22:00

It started with toilet paper and aluminum cans, then bicycles and lumber. The world has gone through wild cycles of demand and supply over the last year, but not many people could have predicted this economic brain-teaser: car prices are through the (metaphorical) roof, with no indication of slowing down. 

For decades, conventional wisdom has held up for individuals who are purchasing a car. If you get a brand new car, you’re told that its value depreciates as soon as you leave the parking lot. A used car’s value only went down with time and kilometers. Conversely, if you were in the market for a used car, you could count on paying a fair price given the age and usage of the vehicle. 

In 2021 however, used car prices saw their biggest price increase in 68 years. Here’s what that looks like, according to Business Insider

An inflation by any other name...

Used car prices 2018 - 2021 chart

When the May consumer price report was published earlier this year, there was one glaring anomaly that, given the circumstances, was very alarming. The US was finally showing signs of coming out of the pandemic-induced recession, and business trends were looking up. However, the data showed inflation rising at the fastest pace since the 1990s. Some people (and economists) are using this data as signs that a long inflationary period is on the horizon. 

Could the government policies and market trends during the pandemic actually lead to a multi-year, super-inflationary period?

Turns out that the trend was driven in large part by the uptick in just a few categories. According to Vox.com, about half of the increase in prices could be attributed to just four categories: used cars, rental cars, hotels, and plane tickets. Notice a pattern?

percent change spendings by categories 2020 - 2021 chart

Source: Vox.com

Demand for cars and travel: Fast and furious

In a normal year, used car prices typically rise about 1% annually. In 2021 so far, used car prices are up nearly 30 percent. Two factors are behind this unprecedented rise: supply chain disruptions in the new car market due to a global shortage of semiconductor computer chips, and the available inventory of cars.

The semiconductor chip shortage: This has been a weird year for semiconductor microchip manufacturers (and everybody else). Car manufacturers cancelled orders for new chips early on in the pandemic because of low forecasted demand, but the opposite scenario turned out to be true. Earlier in the year, there was a major shortage of microchips, especially for North American car companies like Ford and General Motors. Fewer new cars were manufactured or brought over to the US. 

Available car inventory is low: With almost no US company able to manufacture new cars, used vehicles became harder and harder to come by. This led to a continent-wide inventory shortage. There just aren’t enough cars as there are potential car buyers. 

Dialing it in: how do these macro-trends impact you and your financial goals?

At first glance, it may seem like buying a car is not a financially feasible decision anymore, at least in the near future.

However, the rise in car prices have led to an unanticipated bonus for potential car buyers: auto loan refinancing approvals have increased 66% since May 2020, for the most part due to the rise in vehicle values and their positive impact on loan-to-value ratios (more on LTV later).

It’s a win-win. Sellers get the immediate payoff from the current prices, especially if they’ve been wanting to sell or trade-in their wheels for a while. 

Buyers are getting approved for auto refinance requests more than ever before. As vehicle values go up, the Loan-to-Value ratio adjusts downward automatically. Since a lower LTV makes it easier (and cheaper!) for borrowers to refinance, this is a great opportunity for buyers in the market.

Loan-to-Value (LTV): what it means and why it matters

LTV - loan amount by car value formula

LTV, or Loan-to-Value, is an important ratio to know when you’re financing a large purchase like a car or a house. It is a measure of risk, showing lenders (and buyers) to what degree a loan is backed up by a tangible, real asset. 

LTV is calculated by dividing the loan amount by the fair value of the asset. Say the car that you’re purchasing is $20,000 and you get a loan for $15,000, your LTV ratio is 75%. That means that 25% of the appraised value of the asset is not covered by the loan. 

The Loan-to-Value ratio is an important consideration when lenders are figuring out who they can loan out to (and at what rate). LTV ratios trending lower are great news for borrowers who may not have been able to get approved for auto loan refinancing in the past. Similarly, borrowers who already qualified for a refinance will get better loan terms if they apply now. 

Advantages of refinancing your auto-loan

According to Experian, the average loan amount for a new vehicle is $33,739, and a used one usually runs up to about $20,723. Since a car is a major purchase for most people, going for refinancing while approval rates are so high can help you lower your interest rate, reduce your monthly payment, and improve your cash flow. 

Essentially, refinancing a car loan involves borrowing money from a new lender to pay off the current car loan lender in order to get more favorable rate terms on your new loan. Here are more details on how you can benefit from refinancing your car loan:

1. You’ll end up paying less interest

Most borrowers will end up paying less interest over the term of their loan if they refinance. Here is a calculator you can use to find out how much money you’d be saving through a refinance. The final amount depends on the remaining life of your loan and your new rate, but usually taking a few hours to refinance your auto loan can add up to hundreds (if not thousands) of dollars over years. 

Loan savings calculation

2. You can improve your cash flow

If you purchased your car a few years ago, you would not have had access to today’s historically low rates. Or maybe you financed your car through the car dealership, which generally doesn’t have the lowest rates in the market. Finally, if your credit score or income was lower than what it is right now, you can almost guarantee a lower rate through a refinance. 

While there are fees associated with refinancing an auto loan, borrowers almost always save more than they spend. Generally, if you refinance early on in the life of the loan, you’ll save more money. Personal finance website Credit Karma found that the average savings for members who refinance loans through its service is $3,000, or about $55 per month.

3. Your LTV value will most likely improve

Refinancing your auto loan may lead to a lower LTV ratio. Your car gets a brand new appraisal during a time when car valuations are much higher than previous years, so the ‘value’ part of the Loan-to-Value ratio goes up. A lower LTV in turn can allow you to make smaller monthly payments, if that is what fits into your budget right now. 

It also means you have more equity in your asset (your car), and you can use that higher valuation to support other financial moves (like using it as collateral for a business loan, etc).

Why now is the perfect time to refinance

The pandemic caused an unprecedented reduction in the supply of both used and new cars. And pretty much immediately, prices went up. This market bubble, combined with the historically low rates that the government has introduced, presents an opportunity for car buyers to refinance their car purchase. 

With a 66% increase in auto refinance approvals since last year, borrowers should take advantage of market trends while they can. There is a strong case for consumers to secure a refinance during a period of historically low interest rates and high car values. 

If you’ve been thinking about refinancing your auto loan, now is the time to apply. Unlike refinancing a mortgage, refinancing a car loan is extremely easy. It can almost entirely be done online and within a couple hours in most cases. 

Prospective buyers who did not get approved for auto loan refinancing even a few months ago might be hesitant to try again, but remember that the lower LTV ratios right now mean that your application is more likely to get approved without you having to take any additional steps. 

Consumers with strong applications (great credit, stable income, low debt, for example) may get even better loan terms. Rates are as low as 2.25% right now, making the cost of borrowing almost negligible. Simply put, borrowers benefit when rates are low. If you’ve been looking for a way to cut down on your monthly expenses, this is one expense that can make a huge difference.

Although car values are expected to remain high for another few months, the truth is that a trend like this quickly gets corrected through policies and market forces. Consumers and borrowers who have been on the fence should take advantage of this market sooner rather than later and refinance their auto loans while conditions are still so favorable. 


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*APR and Fees Disclosure: Auto Approve works to find you the best Annual Percentage Rate (APR), which is based on factors like your credit history, vehicle and desired payment terms. Fees to complete your loan refinance vary by state and lender; they generally include admin fees, doc fees, DMV and title. Advertised 6.24% APR based on: 2019 model year or newer vehicle, 730 minimum FICO credit score, and loan term up to 72 months. All loans subject to credit and lender approval.
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