Record number of buyers opt for $1,000+ car payment

Once you've earned it, many might imagine, you should be able to spend it any way you want. You want to spend $1,000 a month or more on a car payment, who has any right to tell you that's a really bad idea?

Spoiler alert: I'm about to tell you, it's not a good idea for many people. It's really not.

Just four years ago, only 4.2% of consumers who financed a new vehicle in the first quarter of 2019 signed the dotted line and agreed to pay $1,000 or more a month for car loan on a new car, SUV or truck, according to Edmunds data.

Flash forward. During the first quarter this year, that number has jumped up to 16.8% — a record 1 out of 6 buyers — who committed to a monthly payment of $1,000 or more, according to Edmunds. We were looking at 10.3% in the first three months last year making such high payments, up from 6.2% in the first quarter of 2021 and 5.2% in the first quarter of 2020.

It's shocking to see the steady growth in astronomical payments. After all, most of us don't feel that much wealthier than we did before the pandemic, do we? Did families just ditch the second car now that some work from home, to put it all on just one luxury truck or SUV?

April is National Financial Literacy Month and it's a good time to consider how you split up your paycheck to cover housing, transportation and other needs and, yes, wants. Spending too much on one thing can vastly cut into what you're able to use toward something else.

Higher car prices and higher interest rates are driving up what many, though, are spending toward car payments.

The average monthly payment for new cars, trucks and SUVs hit a record $730 in the first quarter, compared with $656 a month for the same time last year, according to Edmunds. Put another way, new buyers ended up paying an extra $74 a month on average — up 11.3% — than just a year ago.

The average new vehicle was financed for 68.8 months — or more than five and half years — in the first quarter this year, according to Edmunds data. That's down from 69.8 months for the same time a year ago.

The average payments are mind-boggling, too. It's not like you'll pay $700 a month for a car for six years and then own it free and clear for 20 years.

How much of your money should go toward wheels?

Ideally, you don't want to spend a week or more of your pay each month on a car note.

A good ballpark range is that you should aim to spend no more than 15% to 20% of your income on all transportation costs — and that includes insurance, parking, maintenance, gas to put in the tank, and monthly payments.

"While each situation is unique, I believe it’s a good rule of thumb for an individual or household to target about 15% of their monthly net income toward their overall monthly transportation spend," said Mark Munzenberger, financial education manager for the University of Michigan Credit Union.

Net income is your take-home pay or after taxes are taken out of your regular check.

Many families, of course, need more than one car. Two wage earners, for example, could have to travel in opposite directions each day to work. High school and college students living at home can need a car to get to classes, activities and jobs.

And Munzenberger said it is smart to set aside some money in savings regularly to cover new tires, brakes and other big expenses down the line.

If you don't aim to stay within a suggested guideline for a healthy budget, you risk running into a financial squeeze somewhere else.

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The last thing you want to do is start turning to high-cost credit cards to cover everyday bills when the average annual rate on credit cards is 20.11% — up from an average of 16.36% a year ago, according to Bankrate.com data.

If you don't limit what you spend on a car payment, you're not going to be able to save as much money toward bigger goals, such as a down payment on a mortgage for a home or building a nest egg for retirement, either.

"A large monthly car payment might result in an individual only being able to save 3% to 5% into their monthly 401(k), as opposed to 8% to 10%. Over time, that makes a huge difference," Munzenberger said.

The risks go up for those on tight budgets

Many people do whatever they can to make a car payment because they need a car to get to work. But the risks of missing a big car payment go up for those who don't make a lot of money.

"Since the pandemic, ongoing inflation has squeezed household budgets," Trent Graham, program performance and quality assurance specialist at GreenPath Financial Wellness, a nonprofit credit counseling service based in Farmington Hills.

"Interest rates on auto loans have gone up. Personal savings have dwindled. COVID federal aid is no longer available. Credit card use is at all-time highs."

All of those factors, he said, contribute to making it more challenging for some consumers to keep up with auto loan payments.

For example, debt-burdened clients at GreenPath Financial Wellness who were making 30% or less of the median income in their geographic area were twice as likely to be behind on an auto loan in the first quarter this year, he said, than those who made the median income or higher.

Graham noted that 26% of clients counseled nationwide at GreenPath who make half or less of their region’s median income were delinquent on their auto loans during the first quarter. That's actually down from 31% for the same period a year ago for a group of clients in that similar income range.

As a benchmark for the metro Detroit statistical area, the median family income per the federal Department of Housing and Urban Development for a family of four is $89,800. Those in the 50% or lower category would be a family of four with an income at or below $44,750.

On average, debt-burdened clients across the country seeking help from GreenPath faced a $459-a-month car payment in the first quarter this year.

A solid rule of thumb, Graham said, is that anything above 30% of monthly net income is way too much to dedicate to a car payment and other assorted expenses involving owning a car.

The top range could be 25%, he said. Someone making $2,500 per month after taxes — or $30,000 a year after taxes — might be able to spend $625 per month for total transportation expenses but keep in mind that's including the car loan payment, insurance, license plates, gas and other expenses.

"Add all of the monthly costs and then you will see your total transportation costs," Graham said.

Consider your other goals and obligations

Beth Martinéz, who offers assistance in financial and homeownership education through the Michigan State University Extension program, said a consumer who already has a good deal of debt — like credit cards and student loans — needs to spend even less on car payments.

Martinéz suggests that consumers take into account their overall budget and their family. "Will the new payment help or hurt their short- and long-term financial goals?"

If you're thinking about buying a home, for example, you'd want to keep that mortgage payment and other housing costs at 33% of your gross monthly income — and then have between 10% and 15% of your money going toward other debt.

The goal is to keep total debt payments, she said, below 43% to 48% of gross income.

Why you must shop around for financing

Shopping for a car loan before you shop for a car has been standard advice for years — advice too many people never followed. But you need to know what kind of rate you might qualify to get at local credit unions, banks and online. Check out your annual credit report to make sure no errors appear there that might lower your credit score. See www.annualcreditreport.com for a free report.

The average rate on a new, five-year car loan is 6.50% now, up from 4.17% a year ago, according to Bankrate.com data. But many people pay far higher rates if their credit scores aren't strong.

Know the rate you're being offered — as well as the term of the loan — when you talk with anyone, including a dealer, about financing.

"Remember, just because the dealer may offer you a lower monthly payment doesn’t mean that it’s a better deal," GreenPath's Graham said.

"Your payment may be lower because they offered you a loan with a longer term. These loans can have even higher interest rates so you’ll pay a lot more in the long run."

Some 30.5% of car loans taken out in the first quarter stretched out for somewhere between more than six years to seven years, according to Edmunds. The average interest rate on those longer-term loans was 8.4%.

By contrast, the average annual percentage rate on new financed vehicles in the first quarter was 7% — up significantly from 4.4% for the same time a year ago.

Many times, you can find a much better rate if you have strong credit and opt for a shorter car loan that runs three years or four years.

The higher the credit score — ideally, 720 or above — the more likely the consumer will qualify for a lower rate, said Munzenberger, of the U-M Credit Union.

Jessica Caldwell, the executive director of insights at Edmunds, said some of the shift toward higher car loan rates can be blamed on the fact that automakers have not been offering the generous, highly subsidized financing incentives that they have in earlier years.

The Federal Reserve has consistently pushed interest rates higher for the past year to combat inflation. But carmakers also had more room to keep prices high and incentives low, as inventories have been tight.

"As inventories grow, which we expect it will, for new cars in 2023," Caldwell said, "there probably will be more incentives offered for interest rates."

"I do think there will be more of those type of deals, especially since they know that consumers need them."

Where did all the cheap cars go?

Those high car payments often are attached to high car prices. The average transaction price for a new vehicle was $47,713 in March, according to Edmunds.

Five years ago, the average transaction price was $35,794 — or a 33% spike in recent years.

Just 4% of new vehicles sold in early 2023 went for $25,000 or less, down from 24% in 2018. Practically no new cars or trucks sold at $20,000 or lower — just 0.3% — based on Edmunds data.

By contrast, 17% of the new vehicles, including large SUVs and trucks, cost $60,000-plus in March. Five years ago, only 6% of the vehicles sold were priced that high.

Nearly all of the large new SUVs sold in the first quarter — some 94% — cost more than $60,000. That compares with 54% in 2018.

"There's so little choice under $50,000," noted Caldwell, at Edmunds. "That, to me, is bananas. It just getting more and more expensive."

"How long can Americans support this? How high are these prices going to go?"

Some of this, Caldwell said, is being driven by consumers who want more creature comforts, more technology. But it's not leaving much room for consumers who want to stick to a budget.

Caldwell, at Edmunds, says many consumers are stuck in the used car market whether they like it or not as prices climb well above $20,000 for many vehicles. "We see this as a long-term trend. Where do people who don't want to spend all this money go to? They have to go to used cars."

Even smaller new cars aren't as much of an option for many.

Back in 2010, many younger consumers could get a new basic Honda Civic or another small new car for around $15,000 to $17,000 and finance it for a few years. In 2023, that manufacturer suggested retail price is closer to $26,000 or so.

Contact Susan Tompor: stompor@freepress.com. Follow her on Twitter @tompor. To subscribe, please go to freep.com/specialoffer.

This article originally appeared on Detroit Free Press: Car payments hit record average of $730 a month. How much is too much?