Higher Used Car Prices May Push Americans to Buy New

Rising U.S. used car prices could lure more consumers into new car dealerships as the higher value of trade-in models makes buying a new vehicle more affordable, analysts said.

Wholesale used vehicle prices increased for the fourth consecutive month in May, partly due to the drop in volume of so-called off-lease vehicles -- those that are returned after a lease contract expires, said Manheim Auctions (search), the largest U.S. wholesale automobile auction firm.

The values of used cars are up 5 percent compared to a year ago after two years of decline, Manheim said. In comparison, new car prices have increased only 2.5 percent from a year ago.

Used car prices are a barometer for new vehicle sales as about 60 percent of new purchases involve a trade-in model and better prices spur more trade-ins, said Paul Taylor, chief economist at National Automobile Dealers Association (search).

The U.S. auto industry posted a stronger-than-expected increase in sales last month as hefty incentives offset higher gasoline prices. Art Spinella, president of CNW Marketing Research (search), credits some of May's strong increase to higher used car values.

"It can increase new car sales by two or three percentage points annually," Spinella said.

Rising prices motivate people not to wait to trade in their current vehicles, he said.

Consumers are increasingly finding that they owe more on their trade-in vehicles than they are actually worth, mainly because of the growing reliance on a variety of extended interest-free loans. The quick depreciation of the vehicles in the last two years has compounded the problem, which is commonly referred to as an "upside-down" situation or "negative equity".

Strengthening used car prices could reduce the negative equity, Manheim chief economist Tom Webb said.

Hefty incentives, no-interest loans and cash-back deals offered by automakers also have made buying a new vehicle much more attractive than buying a used vehicle.

"At the margin more people will choose to buy new if used car prices are firming in relation to the new car prices," Taylor said.

The reduction of off-lease vehicles in the coming years is expected to further improve the value of used cars. Leasing, a popular option in the late 90s, lost much of its appeal after automakers scaled back on deals to lease a vehicle.

Last year, the number of vehicles that were returned after the lease contract expired fell by 150,000 units, Manheim said. By 2006, the number of off-lease vehicles coming back into the market will be down 1.7 million units from their peak in 2002, according to Manheim.