A used car price bubble? New report says yes

You’ve seen the stories all year – used car prices are rising faster than ever. Inflation has hit US portfolios in many ways in 2021, but perhaps nowhere as intensely as in used car prices.

Could this lead to a bubble?

A new report from accounting giant KPMG says yes. Americans who bought used cars during the current price spike could find themselves driving an asset worth less than they owe. If the bubble bursts, exchange values ​​could collapse.

KPMG built its report, in part, with data from Kelley Blue Book’s parent company, Cox Automotive.

How we got here

A perfect storm of factors combined to quickly heat up the used car market in 2021.

The worst of the economic downturn caused by the COVID-19 pandemic has started to ease. Americans got vaccinated. Government assistance has helped many people catch up on their bills and start shopping again.

Nervous about public transportation during a global pandemic, Americans searched for cars.

But automakers had few new cars to sell. A global shortage of microchips has left the auto industry to build fewer cars than expected. “In the third quarter of 2021, production of new cars fell at an annual rate of around 12 million units,” notes KPMG, while 17 million could have been expected without the collision of several crises.

This pushed up new car prices – the average new car sold for over $ 46,000 in November, a 13% increase in just one year. The higher prices of new cars have pushed many buyers into the used car market.

But the used car market has been rocked by its own wave, which dates back many years. Automakers had cut back on production for several years after the 2008 recession. This left fewer dealers with older, higher-mileage used cars that sell for less than $ 10,000. With more buyers but only a small supply of newer, expensive cars, the used car market has experienced inflation that has made new car prices seem tame.

In November, the average used car sold for over $ 27,000, an increase of 27% in just one year and 41% above the pre-pandemic average of two years ago. year.

What could happen next

“History tells us that the current frenzy in the used car market will end,” says KPMG. As the microchip shortage and other supply chain issues abate, “the huge auto-manufacturing machine will be stepped up to speed and the dealership lots will be full again.” When that happens, the used car market could collapse.

If the normal relationship between new and used car prices is restored, KPMG says: “This would mean that used car prices would drop about 30% below where they are today. The drop could be less dramatic if inflation persists.

What this means for drivers

Among the implications of such a drop, KPMG says:

  • By the end of 2021, some 17 million consumers – the equivalent of a full year of sales – will own grossly overpriced used vehicles. This number is increasing by almost 2 million used car buyers per month.
  • More than half of these overpriced vehicles are financed, posing potential risks to lenders and investors in the $ 1.4 trillion auto loan industry. In addition, these buyers will have little or no equity in their cars, making future car purchases unaffordable.

KPMG analysts can’t say when the price cuts might start, noting that inflation could be with us for a long time. The current political situation makes government solutions difficult to predict.

The report describes four possible trajectories for used car prices. All show a return to balance between October 2022 and October 2023, potentially leaving millions of Americans upside down on their used car loans.

“We expect the market to anticipate the recovery in the supply of new cars in advance and begin to review the price of used cars before the new car lots are full and the Used car demand does return to normal, ”the report notes.

Related: Now is the Time to Buy, Sell, or Trade a Used Car?

There is little good news for buyers in the projections. Note that the average car on American roads is now over 12 years old. So many of those who have bought late model used cars can hold onto them long enough that a collapse in trade-in value doesn’t affect them much.

But, if you can, it’s still a good time to fix your existing car and keep it running until prices stabilize.

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