Car payments are becoming larger parts of borrowers’ DTI ratios for longer and longer!
According to Autotrader, the average car loan has increased to almost 70 months in the fourth quarter of 2021. Ouch. That’s a long time—nearly six years. I mean, I went from the first day of 7th grade to a high school graduate in less time and that seemed like forever. Plus, when a borrower buys a new or used car, they are saddled with debt that could impact their ability to buy a home…for years.
The average monthly new car payment is nearing $700
Recently, Bankrate said the average monthly car payment hit $677 for new cars and $515 for used cars. Depending on a consumer’s income, that is a lot of money. Heck, those are rent payments in parts of the country!
How did this happen? Well, as some parts of the country emerged from lockdowns in 2021, Experian reported that pent-up demand for automobiles soared. Consumers weren’t driving much during 2020, but if they did need to get somewhere, many no longer wanted to take mass transit and they needed a car. Then, 2021 and 2022 came and suddenly, many were back on the road. Then, we throw in the “chip shortage,” other supply-chain issues and commodity costs skyrocketing, all those impacted the cost of new and used cars due to the massive demand and reduced supply.
An expensive car payment impacts a borrower’s DTI
Consider what a car payment does to the average consumer debt-to-income (DTI) ratio. It throws it out of balance in many cases, as DTI includes all loan payments during the month.
Many look at buying a car as a fairytale that will bring them new experiences, so, once upon a time, the thought of buying a new car sounded like a great idea until it came time to apply for a mortgage loan or a home equity loan. Now, the lender is looking at that monthly, new car payment of $677 that potentially has seven years left on the loan. This burden could make a borrower ineligible for a home loan or the interest rate for the mortgage loan could be higher than expected, or at the very least, reduce their ability to afford a home.
Think of it this way… If a potential homeowner buys a new car and has a monthly $677 payment, then that borrower can afford approximately $80,000 – $100,000 less for a house (pending loan terms and credit score) and that purchase power restriction stays with the borrower until the loan is paid off (in our example that is seven years). After all, in Q3 2021, auto loan debt reached an all-time high of $1,430,000,000,000. Yes, that’s 1.43 TRILLION, with an average auto loan balance of $20,987.
A factor in home price deceleration, stabilization or reduction?
So, today, the average homebuyer, who just purchased a new auto, will be able to spend nearly $700 per month less of their DTI towards a home due to their car loan commitment. And according to CNBC, if we next consider today’s rising mortgage rates, a potential homebuyer is now paying an additional $700 per month more than they were one-year ago on a $400K home today due to mortgage interest rates being at approximately 6% vs. 3%.
This one-two punch creates nearly $1,400 per month of less home purchasing power, which could then reduce a buyer’s ability to afford a home by $160,000 – $200,000 and potentially ‘force’ home sellers to make downward pricing adjustments in order to increase the potential pool of likely buyers for their home.
What is the potential impact for the housing market?
With higher car payments, mortgage rates and pressured DTIs, it stands to reason that a number of consumers will be shut out from buying homes. Aside from what that means for homebuyers, think about the impact on the housing market in general. Will the lack of affordability dampen demand, therefore bringing home prices down? Will the reduction in demand create a reduction in cost (even if supply remains constant) as the good, old supply and demand curves should point to? If home prices dip to more obtainable levels, will mortgage applications begin to inch upward and create more of a housing market reset vs. recession? It seems only time will tell if there is something positive to come out of this all.