Half of U.S. households can only afford a $400 car payment. Their options - new or used - are scarce.

By Venessa Wong

The large number of buyers seeking a low-cost, entry-level vehicle are underserved in today's market

Car affordability may be improving this year, but prices remain far above levels that the average consumer can comfortably pay.

Tesla (TSLA) CEO Elon Musk told investors Tuesday that the company is trying to solve "the fundamental affordability question." "The vast majority of people are living paycheck to paycheck," Musk said on an earnings call. "It actually makes a difference if the cost per month for lease or financing is $10 one way or the other."

Tesla did not address rumors of an entry-level $25,000 model, but the company has accelerated plans to make more-affordable EVs. It announced last week that it will cut the U.S. prices of its Model Y, Model X and Model S vehicles by $2,000 each.

"The $25,000 car is fast becoming a unicorn for any automaker," said Edmunds Consumer Insight Analyst Joseph Yoon. Still, it's the price point most Americans can actually afford.

Consumers are dealing with a "car-ownership affordability crisis," according to a recent report by the auto-insurance app Jerry. New-car buyers in March paid over $47,000 on average, according to Kelley Blue Book.

"The typical American household can afford a car payment of around $400 a month," Cox Automotive Chief Economist Jonathan Smoke said last year. "With an average monthly payment of nearly twice that, the new-vehicle market remains heavily skewed toward the most affluent buyers."

Materials from the company show about half of households can afford a $400 monthly payment. A popular budgeting rule of thumb is to spend less than 10% of take-home pay on car payments. "Ten percent is the max if a household allows for reality for what housing costs are today and other forms of debt," Smoke said. As households in the middle-income range can afford auto payments ranging from about $300 to $600, they can think of $400 as a "magic payment" level, he said.

At current interest rates for new cars, if a buyer wanted to bring their monthly payment close to $400, they could only borrow up to $20,000 on a 60-month loan, according to FICO's loan calculator. The problem is, "the $20,000 new vehicle is nearly extinct, and the $25,000 new vehicle is next in line," according to a new report by Edmunds. Only 0.4% of new vehicles sold this past February were $20,000 or under, compared with 7% in February 2019.

By 2024, Americans had just five options for under $20,000, according to Kelley Blue Book: the Kia Rio, Kia Soul, Hyundai Venue, Mitsubishi Mirage and Nissan Versa. U.S. News and World Report named the Kia Soul and Kia Rio the best cars at that price point.

The average payment is now $744, according to Kelley Blue Book. That's down from $795 in late 2022 but far higher than the $400 price point, which is "a sweet spot for a lot of first time buyers," said Mark Schirmer, the director of industry insights at Cox Automotive, calling them an underserved market.

"You have got to do some pretty big gymnastics to be able to get to a $400 payment right now," such as a large down payment, he said.

Using the 10% rule for car affordability, a household would need to take home more than $7,440 after taxes each month, or $89,280 annually, to afford the average $744 payment on a new vehicle. In reality, median household income after taxes was $64,240 in 2022, the most recent year for which Census Bureau data were available.

Even before the pandemic, the market had already begun shifting away from small, affordable cars, Schirmer said.

By 2020, Ford (F) had stopped making any sedans for the U.S., citing changing consumer preferences. Chevrolet announced in 2022 that it would no longer make the Spark, which started at $13,600. A spokesperson for Chevy parent General Motors (GM) told Car and Driver at the time that car buyers seeking "an approachable price still have strong options within Chevrolet's family of compact SUVs."

Consumer demand for higher-priced car models rose when interest rates were low, and during the global computer-chip shortage in 2021 and 2022, many automakers switched to producing higher-priced models. "If you could only make a certain number of cars, it made sense to make your most profitable model or to favor profitability," Schirmer said.

The climb in new-car prices has driven more consumers to buy used cars, including electric vehicles, which now cost about half what they used to. Dealers sold 1.66 million used vehicles in March, up 10.9% compared with a year earlier. Still, the average amount financed on used vehicles is about $27,800, and interest rates for used cars are typically higher than for new cars. The average monthly payment on a used car is $549, according to Edmunds data.

Carmakers are taking note of returning demand for less-expensive cars. Ford told investors this week it expects to be able to sell an EV for $25,000 to $30,000 at a profit.

See also: Smart ways to shop for used EVs, which now cost half as much as they did in 2022

We want to hear from readers who have stories to share about how declining car affordability is affecting them. If you'd like to share your experience, write to readerstories@marketwatch.com. A reporter may be in touch.

-Venessa Wong

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04-27-24 1155ET

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