Here’s a term you might not have heard: automotive share of wallet. If you’re one of the 1.6 million Canadians who will buy a new light vehicle this year, you know all too well the bad news here, even if you haven’t thought about it consciously.
‘Automotive share of wallet’ is a jargon-y way to describe the percentage of family income spent on a new car payment. The latest research from J.D. Power and Associates shows that because middle class incomes are going backwards thanks to inflation quietly creeping forward and incomes stagnating, Canadians are emptying a bigger percentage of their wallets when buying a new vehicle – even though the average new vehicle loan payment has been essentially flat at about $528 since 2007.
“According to Statistics Canada, the average after-tax income for most family types has dropped, or failed to keep pace with inflation. As a result, vehicle buyers and manufacturers have resorted to lengthier payment periods and increased debt loads to help maintain the delicate balance,” says J.D. Power.
The drop in middle class income has been slow, which is likely why most Canadians have not taken great notice of it – at least not consciously. J.D. Power points out that Stats Can figures show that in 2007, the average married couple with no children earned $6,800 a month, after tax. The average new car payment represented 8.0 per cent of that income in 2010, versus 7.8 per cent in 2007. Car payments, then, are taking up a larger share of your wallet now than they did before the great financial cataclysm of 2008-2009.
According to J.D. Power, the average finance term today has ballooned to 62 months, versus 50 in 2007, in order to minimize the impact of automotive share of wallet on a monthly basis . But averages don’t really tell this story well enough. Here’s something that does: 40 per cent of buyers today purchase a vehicle with a payment term of 72 months or greater, versus 6.4 per cent in 2007.
Six years. That’s how long four our of every 10 new cars buyers are taking to pay off a car loan. A lot can happen in six years and one big worry is “negative equity.” On the street, this is called being underwater – the car itself is worth less than the total value of the remaining payments.
For many, then, it would make financial sense to simply walk away, to stop making payments and allow that vehicle to be repossessed. This has the potential to become a nightmare scenario for car companies and financial institutions. Imagine what would happen if enough owners were to walk away in despair and out of their own self interest.
“With finance terms lengthening, the number of new vehicle purchases that fall into that category is on the rise. In 2007, 17 per cent of transactions were underwater, compared with 26 per cent today,” says J.D. Power.
That worry aside, monthly payments remain manageable – keeping the automotive share of wallet within reason – but there’s a cost to that and it’s not insignificant; nor is it something the middle class can be expected to bear forever: “In 2007, the average total cost of a vehicle loan (spread out over four years) had a loan-to-cost ratio of 107 per cent. Today, due to the extended payment terms, that ratio has risen to 114 per cent, making new vehicles significantly more expensive in the long run,” notes J.D. Power.
Four out of 10 new vehicle buyers are now shopping the monthly payment, not the sticker price, as you would if you were a cash buyer. This means the manufacturer’s suggested retail price is becoming increasingly irrelevant in the marketplace overall, notes J.D. Power.
“Today’s vehicle buyers will trade tomorrow’s total cost in order to balance the monthly checkbook,” says J.D. Power.
Thus we’re seeing car companies, their dealers and financial institutions become more and more creative in finding ways to keep monthly payments at a place where the automotive share of wallet doesn’t become so large that it hammers overall new vehicle sales.
But it does not take a genius to see that in the long term this trend is not sustainable. Either middle class incomes must rise, inflation included, or new vehicle prices must go down. If one or the other does not happen, new car sales will eventually begin to slide, and they could slide dramatically.
How bad might things get? No one can know for certain, but when the great economic crash came in the United States – a crash from which we in Canada have been significantly insulated thanks to our broader social safety net and healthier financial institutions – new vehicle sales down south collapsed, from 16.5 million a year to around 9.5 million at their lowest.
Yes, sales in the U.S. have been on the rise for a couple of years now, but no one expects a recovery to 16.5 million in annual sales – not as long as the 99 per cent keep seeing their real incomes go backwards. Now you know another reason why the Bank of Canada is so concerned about debt loads in Canada.