In this month’s edition of Guidelines we included an article on the current state of used vehicle demand, and in it we discussed how multiple signs – retail sales, price growth, and intention indicators – point to continued, albeit slowing, growth in this area.
We believe that one of the factors supporting demand is the positive equity position that consumers find themselves in with their current vehicle.
It’s common knowledge, at least in the industry, that used vehicle prices have been on the rise and that depreciation has slowed over the course of the past four years because of deteriorating late-model used vehicle supply and stout consumer demand.
In fact, NADA estimates that used vehicle depreciation averaged just 13.1% from 2009 through 2011, or some nine points better than the 22% average rate of loss recorded in the ten years prior (see our recently released white paper “Volatility in Used Vehicle Depreciation” for more detail on depreciation trends).
This slower rate of value loss means that consumers should have more equity in their used vehicle today than they did just a few short years ago.
To illustrate this, we’ll use 2006 and 2009 model year versions of the Ford Explorer XLT 4WD equipped with a six cylinder engine and calculate loan terms for each predicated on their respective calendar years. We’ll then compare the difference between estimated amortized loan balances and NADA’s average trade-in values to assess changes in equity position.
The Explorer is a good model to use as an example because it remained relatively unchanged over the period which means that advances in product design didn’t influence improvements in depreciation.
As for disclaimers, amortization schedules were created with new vehicle prices sourced from JD Power retail transaction data and interest rates as reported by the Federal Reserve, with each input specific to a given model- and calendar year. Loan terms for each scenario were set to sixty months (five years).
Based on these terms, the consumer that bought their new Explorer at the beginning of 2006 didn’t reach an equity position until they made their 41st loan payment or almost three and a half years post-purchase, and after 45 months of ownership, their stake in the asset had reached $2,895.
Fast forward three years and the consumer who purchased their utility at the start of 2009 reached an equity position in just twenty-six months, or fifteen months faster than the individual who bought in 2006. Even better, the equity stake after 45 months of ownership jumped to $6,830, or nearly $4,000 more than what was accumulated some three years earlier.
That’s a much larger chunk of change that a consumer has to apply towards the purchase of a new – or newer used – vehicle.
Of course equity growth hasn’t been this extreme across the board, but even in less dramatic cases it’s been meaningful nonetheless. Turning again to our amortization exercise, after nearly four years of loan payments, the equity stake on a Honda Accord Sedan 4D LX outfitted with a four cylinder engine grew from 45% to 52% from 2006 to 2009, or an increase of $1,423.
Even though this is something of a hypothetical exercise and things like down payment requirements and longer or shorter loan terms can modify results a bit, differences overall will be relatively minor and the trend we presented here will still hold true. The equity position that consumers find themselves in today is better – and in certain cases, dramatically so – than it was three years ago.
This will help facilitate the release of pent up demand for the growing number of consumers making the jump off of the sidelines and into a new or pre-owned vehicle.