Why Car Shoppers Should Wait 6 Months to Buy

For the next few months, car buyers are likely to find higher prices and shrunken selection.

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You're sick of $80 fill-ups and you want a more economical ride. You nursed an old jalopy through the recession and it's finally about to give out. Your family is outgrowing the jaunty little runabout you bought before having kids. Or maybe you just feel like you deserve to indulge yourself.

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There are plenty of valid reasons to buy a new car, and the rising pace of car sales so far this year shows that after three years of frugality, consumers are acting on their impulses. But it's suddenly looking like a seller's market that favors dealers over buyers. "If you really need a car, you should buy immediately," says Alec Gutierrez of car-research site kbb.com. "But if you can wait a few months, you should wait." The unusual confluence of rising gas prices, supply-chain disruptions caused by the Japanese earthquake, and a shrunken auto industry are making it a tough time for buyers. Here's why car shoppers might want to sit on the sidelines for awhile:

Prices are rising. At the start of the year, automakers were still offering rebates and other familiar come-ons to move the metal. But a surprising spurt in the demand for cars has led to fewer incentives and a spike in the average transaction prices buyers are paying at showrooms. Car-research site kbb.com says the average transaction price of a car has risen by about 4.3 percent so far this year, with the prices of small cars and hybrids up by more than 10 percent. That doesn't usually show up in a higher sticker price. But as demand for hot cars goes up and manufacturers reduce rebates, dealers become more reluctant to haggle. So instead of dropping their price by, say $1,500, they might only drop it by $500—a $1,000 price hike, in effect.

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That trend seems likely to intensify, with prices peaking over the summer or in early fall. The huge earthquake that struck Japan in March wrecked a number of supplier plants that provide paint, rubber components, processors, and electronics to many automakers worldwide. It also left Japan with a nationwide power shortage that's causing rolling blackouts and forcing manufacturers to slow or shut down assembly lines. Toyota, as one example, has cut its production in Japan to half-capacity, while production in American factories has fallen even more, due to parts shortages. Toyota says production should pick up by summer, but won't be back to normal until the end of 2011. Other Japanese automakers face slowdowns, too. The parts problem could hit some American and European carmakers as well.

For most vehicles, there's typically two to three months of inventory on dealers' lots, in shipment, or elsewhere in the pipeline. So shortages haven't hit dealers yet. But they're likely to hit by sometime in May. That means prices will probably rise over the summer even more than they have so far this year. A one- to three-year-old used car might seem like a decent alternative, but used-car prices have been rising too, because a sharp slowdown in new-car sales over the last three years has left a smaller-than-usual inventory of used cars. And gas prices around $4 have had the usual effect on car buyers, boosting demand for high-mileage compacts and hybrids. Taken together, those trends are bad news for buyers. "Transaction prices for new cars are near record levels, and used car prices are up, too," economist George Magliano of forecasting firm IHS Global Insight said at a recent conference in New York. "The question is, how high are they going to go?"

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Selection is shrinking. The Japanese parts shortages may not lead to the outright disappearance of endangered models from showroom floors. What's likely instead is that some trim lines, options and colors may become unavailable, with the most popular choices probably running out first. Dealers always like to say they have plenty of cars, and they don't want to publicize any problem that could discourage buyers from paying them a visit. So they may not acknowledge that the car you want isn't available. A better sales tactic would be steering buyers toward cars that are available. So buyers should be more diligent than usual about doing their research, knowing exactly what they want and heading for another dealer if they feel pressured.

Buyers should also remember that a shortage of some vehicles will boost demand—and prices—for competing models that aren't hampered by a parts shortage. Downsizing in the auto industry over the last few years has reduced capacity and lowered inventories for many models, so there's not necessarily a lot of excess supply should buyers switch in large numbers from one model to another. A buyer who can't find the Honda Fit he wants, for example, might consider the Ford Fiesta instead. But if thousands of others did the same thing, Fiestas could temporarily run short, too. Or at least the most popular colors and options packages could.

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Credit should get better. Car sales plunged in 2009 and 2010, partly because consumers didn't want to spend money, but also because banks cut back sharply on loans. Before the recession, the auto-loan approval rate for people with top credit—those able to qualify for zero-percent financing and other sweet offers—was about 90 percent. It's since fallen to about 70 percent. And the approval rate for sub-prime borrowers has fallen from 70 percent to just over 10 percent. That pullback represents a necessary correction, but lenders have also gone too far and shut out many borrowers able to pay back loans. As unemployment improves and lenders become less gun-shy, more buyers will qualify for loans and more will get preferred, lower rates. Interest rates may rise a bit over the next 12 months or so, but most economists think the Federal Reserve will continue to keep rates low until late this year or early next.

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Six months from now, it should be more of a buyer's market. By fall, most automakers hit by parts shortages should be recovering. A production spurt could even lead to a glut of cars. Gas prices are more of a wild card, since they're based on the highly unpredictable politics of the Middle East, among other things. But a sharp move in either direction could aid buyers. If gas prices go well above $4 and stay there for awhile, it could threaten another recession, an unwelcome development that would nonetheless lead to spending cutbacks and discounts meant to lure buyers to showrooms. If gas prices fell to $3 or lower, demand would probably ease for high-mileage cars, which have seen the biggest price hikes so far this year. The smartest shoppers may end up being those who snag a deal on a fuel-sipper when gas is cheap—if it ever is again.

Twitter: @rickjnewman

Corrected on 4/26/2011: In a previous version of this story, Alec Gutierrez's name was misspelled.