Auto loan balances increased by $22 billion last quarter. Are consumers in over their heads?

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Rising car prices and loan rates could spell disaster for drivers.

Key points

• Car prices have risen this year due to shortages in the supply chain.
• This forces borrowers to take on higher car payments – and put their finances at risk.
• Compare your total monthly expenses to your income to determine a monthly car payment you can afford.

Buying a car has always been an expensive prospect. But these days, vehicles are even less affordable due to a massive shortage.

The heart of the problem is actually a shortage of chips – a problem that started during the COVID-19 pandemic and has yet to be resolved. Ultimately, automakers saw their production slow, resulting in a limited supply of vehicles for sale. And whenever you have a situation where the quantity of a given good is not high enough to meet consumer demand, its price tends to increase.

It should come as no surprise, then, to learn that auto loan balances increased nationwide during the third quarter of 2022. That’s according to a new report from the Federal Reserve Bank of New York. But what’s more surprising is that auto loan debt has increased by $22 billion. This indicates that many consumers have taken out large auto loans – and are at risk of falling behind.

If you need a car, you may have no choice but to finance it with an auto loan. After all, you probably don’t have $30,000 or $40,000 in your savings account to directly pay for a new car.

But if you’re going to incur the expense of a car loan, you’ll need to make sure it really fits your budget. Otherwise, you could be setting yourself up for a world of financial stress.

How many cars can you afford?

There’s a formula consumers should follow when it comes to buying a home: Don’t let your housing costs exceed 30% of your income. But buying a car is more tricky, because such a formula does not really exist in this context.

Therefore, your best bet when buying a car is to look at your total fixed monthly expenses, compare them to your income, and see how much room you have left. Say you bring home $3,000 a month and currently spend $2,000 a month on essentials like housing, food, utilities, and health insurance. That leaves you with $1,000 left over — but that doesn’t necessarily mean you can afford a $1,000 monthly payment for the car.

You might need some of that $1,000 to pay for non-essentials like streaming content and social events — things you probably don’t want to cut out of your life entirely. And you might need some of that money to boost your savings or fund your IRA for retirement. So your best bet is to really take a close look at those numbers and land on a reasonable car loan payment.

Higher borrowing rates could be a problem

Unfortunately, not only are car prices rising these days, but so are auto loan rates. In fact, mortgage rates are higher across the board, making this a really bad time to finance a car.

If you are considering applying for a car loan, check to see if your credit score is in good shape. The higher this number, the lower the rate you are likely to qualify for. A lower rate could make you less likely to fall behind on your loan repayments.

Remember that taking an overpriced car can have many negative consequences. If you are late with your loan payments, it could cause your credit score to plummet and put you at risk of having your vehicle repossessed. So you better land on a reasonable car payment – even if that means resigning yourself to a vehicle that lacks some of the features you might otherwise have wanted.