It Started: Car Prices Are Falling 50%

What's up, Grandma's guys here! And it's official: after seemingly unstoppable growth, the used car market has begun to collapse. A new report from Black Book just found that subcompact car prices have declined 3.68% in just the last week alone. As wholesale used car values plummet, auto repossessions are on the rise, and a buyer strike ensues, leading to one of the quickest downtrends ever on record.

In fact, the situation is getting so bad that lenders are even warning prospective buyers that their car loan could soon be underwater. With the average new car payment having increased past seven hundred dollars a month, there's a concern that the damage is about to extend throughout the entire industry and then eventually to the car that you have sitting in your driveway.

So let's talk about the current state of the auto industry—the latest data that was just released, how much car prices are expected to fall over these next few months, and then finally how you could use this information not to lose money. On today's episode of "Rich People Are Still Buying Ferraris," before we drive into this information, it would be a wheel clutch if you feel that YouTube algorithm by giving it a like or subscribing if you haven't done that already.

Alright, now if you're not aware of what's going on and why used car prices are about to drive off a cliff, here's what you need to know. Because once you understand this, everything else will begin to make a lot of sense. To start, you've probably noticed that throughout the last few years, car prices have been getting significantly more expensive. In fact, I've mentioned it before, but car prices have outperformed the stock market in 2020, 2021, and 2022. They've increased twice as much as home prices, four times more than contemporary art, and with 80 percent of new cars selling above MSRP, it causes you to question what on Earth is going on and when is this going to come crashing down.

Well, as far as why car prices have become the best-performing assets since shorting Facebook, look no further than three main categories that are eventually coming to an end. The first would be limited production. See, in order to actually manufacture a vehicle, you need all the necessary components, and one of those is an aspect that many people forget about: chips. Semiconductors like this make it possible for the car to operate everything from windows, sensors, ignition, navigation, and nearly every other random aspect of the car that no one pays any attention to until it breaks.

In fact, a modern car now requires in excess of several thousand of these chips in order to function. Even though that sounds like a lot, the auto industry only uses about three percent of the entire chip supply, while the rest gets used by consumer electronics, which saw record increases throughout 2020 and 2021. Those got priority as a result of manufacturing delays, lack of labor, and a supply chain crisis that led to a shortage of chips and therefore a shortage of vehicles being produced.

Even now, Toyota cut production by 50,000 vehicles in July. Kelly Blue Book explains that a typical semiconductor production line could involve 700 manufacturing steps across 14 weeks, leading to less cars being built.

Second, we have low interest rates. Up until a few months ago, car buyers were able to obtain record low interest rates with terms as long as 12 years. Meaning, just like the housing market, cars became that much more affordable to purchase. As a result of excess demand and cheap borrowing, the average car payment began to exceed 700 a month, and for one in eight borrowers, that amount was over a thousand dollars a month. So, just like in the housing markets, the more purchasing power Americans had, the more they drove prices higher.

Third, we have greed. Now, of course, we can't be too surprised here. The fact is, if you're running a business, you should be prioritizing the shareholder. But in this case, auto manufacturers realized that they could charge more if they produced less, and that's what they're doing. Kelley Blue Book recently ran an article explaining that manufacturers will consciously under supply demand, with BMW saying that they plan to clearly stick with the way they manage supply to keep their pricing power at the current level. Mercedes-Benz is also following the exact same path while simultaneously shifting gears towards the higher luxury end, which basically means they'll probably rename the exact same thing to sound fancier so that they could charge more.

On top of that, Ford even suggested that they may move to a built-to-order business model so that there's never a car that goes unsold and they'll never have to reduce prices on old inventory to make way for something new.

However, in terms of what this means for the future of the market and why car prices are beginning to come crashing down, here's what you need to know. The market is probably going to look substantially different in the next few months. That's because all of a sudden, car repos are exploding.

Usually, this would be attributed to coming off record lows with loan forbearance, where any uptick would appear significantly exponential. But in this case, the Consumer Financial Protection Bureau came on record to say that loans originated in 2021 and 2022 are starting to show higher delinquency rates relative to the loans originated in previous years. The situation is getting so severe that banks are warning that falling prices would leave many of their borrowers underwater, where they owe more on the car than what the car is worth.

Wells Fargo said that higher loss rates for loans that originated late last year contributed to an increase in write-offs for that period. On top of that, the Mishtak blog also referenced a tweet where buyers are beginning to walk away from their cars if they're unable to pay back the loan. In a way, it makes complete sense.

Just consider this: in most cases, the general rule of thumb is what's called the 2410 rule. It's a 20% down payment on a four-year loan where you pay no more than 10% of your total income on transportation. But what actually happens is the complete opposite. Instead, the average down payment is just 11.7% on a 72-month loan with the car that's kept for 71.4 months. So basically, people haven't even finished making their payments on the first car before they sell it and roll that over into a brand new loan that starts the process over again.

However, as we all know, car prices don't usually increase in value as they have been, and with prices beginning to decline, KPMG predicts that used car prices could drop 30% as more supply hits the market, while Ally Financial believes that we're in for a 20% decline throughout the next 12 months. This presents the ultimate problem with car finance: at the top of the market, from which values are beginning to decline, it's easy to see how a buyer could very quickly and severely be underwater.

When that starts to spread throughout the entire market, it quickly becomes everyone's problem. After all, imagine you took out a forty-thousand-dollar loan to buy a car that's now worth twenty-five thousand dollars, and you can no longer afford the seven hundred dollar a month payment. What do you do? You can't sell the car because you don't have the fifteen thousand dollars to come out of pocket to get rid of it, and you can't refinance it because rates are substantially higher today than they were a year ago.

So many people are beginning to make the choice to walk away, give it back to the bank, and let it be their problem. Now, in terms of how this will affect the entire market, let's take a look at the few companies that really stand out. The first would be CarMax. This is generally regarded as a fairly stable business model where you could bring in almost any car, get an immediate offer valid for up to seven days, and once accepted, CarMax could turn around and flip it for a profit.

But lately, their stock has fallen by 60%, which is a sign of trouble for the entire industry. On top of that, they made it clear that their customers are being hit with a triple whammy: inflation is making cars less affordable, rising interest rates make them tougher to finance, and consumer confidence is ebbing. They've also been shifting inventory from auction to retail with hopes that they could get a higher price, leading to, of course, more inventory causing prices to fall even further.

As I mentioned before, a subcompact mid-sized full-size car saw between a 1.72% and 3.68% drop week over week, which means that the current trajectory prices could fall substantially higher throughout the end of the year. This then brings us to the epitome of 2020 euphoria, Carvana. They are the used car retailer that's famous—or I guess infamous—for their 24-car vending machines throughout the United States, where you could literally walk up, insert a coin, and drive away with a used car.

Except there's a problem: Carvana has lost an average of $3,255 for every vehicle sold, and their stock is down more than 95% within the year. In fact, they've only ever turned a profit once in 2021, when used car prices suddenly increased, making their inventory more valuable. Besides that, they've been on a path of losing money hand over fist, and with car prices declining even further, it's probably going to get a lot worse.

In fact, Black Book reported that wholesale prices have fallen about 10% since September, and with Carvana holding on to potentially a hundred thousand cars, that is a massive loss that has to go somewhere. Now, in terms of what's happening today, first we have stricter loan requirements. It was reported that once Wells Fargo began to see signs that their borrowers were falling behind, the firm moved fast to tighten underwriting standards, which caused auto loan origination volumes to plummet 40%.

They even go so far as to say that those borrowers are now reevaluating whether it's worth remaining current on their payments. Something that could prove challenging for the auto finance sector going forward. Fifth Third Bank also seconds this when they say that they've throttled back on the production of loans, especially now that prices are falling.

That of course brings us to second, cheaper vehicles. Just like we've seen with stay-at-home stocks like Shopify, Netflix, Zoom, Peloton, and so many others that saw a big run-up and then a crash, the same is beginning to happen with vehicles, which doubled in price and now are beginning to come back down. Today, prices are about 20% below their peak and they're currently falling by an estimated 2% to 4% every single month.

Thereafter, third, if lenders see heavy enough losses, it's likely to be reflected in the stock price for banks and auto manufacturers, lowering the overall market. For example, Ally currently holds about six percent of the entire auto loan market, followed by Wells Fargo, Chase, and Capital One. Even though many of their stocks have already taken a hit, it's unclear exactly how much is priced in, and depending on the economy, unemployment, and interest rates, it could get a lot worse.

Now, on the bright side, some analysts say that this is not the end of the world and that car prices will eventually return back to normal. But with personal savings now having declined to its lowest level in 10 years, it's unclear if we might see an over-correction before things resume back to the way they were.

So in terms of my overall thoughts, it's pretty simple. If you have a car that you can no longer afford or if you're worried about losing your job and falling behind, now could be a good time to sell your car and get into something more affordable, or speak with your bank about potential repayment options because they're most likely willing to work with you. The other good piece of news is that most auto loans have a fixed interest rate, so even if the buyer owes more on the car than what the car is worth, as long as they can continue making the payments, the solution is to simply drive the car longer than expected, and eventually you'll break even.

In the big picture, I'd absolutely expect car prices to continue declining. But while that happens, auto manufacturers may very well scale back on their production to keep their inventory from falling too far. And that is something to watch out for. In addition to that, I would expect more oversight to be given to auto loans, which for the most part are very poorly regulated. Unlike houses, it's very easy to pay more than what the car is worth without any appraisal whatsoever.

This would likely result in stricter income and credit requirement environments, as well as a verification that the car is actually worth the price that the buyer is willing to pay. But all in all, I think this is a sector of our economy that's just not getting enough attention, especially when more than 90 percent of U.S households own a car. So at the very least, the more people that are aware of what's going on, the less likely this is to become an issue again in the future.

So with that said, you guys, thank you so much for watching! As always, feel free to add me on Instagram. Enjoy! Thank you so much for watching, and until next time.