U.S. auto sales will extend their winning streak in 2016 for a seventh consecutive year of increases, reaching a record high before sales begin to retreat in 2017 as interest rates tick higher and pent-up demand eases, according to a new report by TD Economics, an affiliate of TD Auto Finance and TD Bank, America's Most Convenient Bank.

"A healthy domestic economy and favorable financing terms should help to propel auto sales higher this year," said Dina Ignjatovic, economist at TD Economics. "Given the massive deleveraging by households in recent years, combined with affordable monthly payment options, the ability of Americans to purchase a new vehicle has improved dramatically."

Strong domestic economy will support sales

Led by a strong economic backdrop and attractive financing conditions, TD Economics projects U.S. auto sales will reach a peak of 17.6 million units in 2016, before edging down to 17.3 million units in 2017. The U.S. economy is on solid footing, with healthy growth of at least 2 percent expected for this year and next. Domestic demand has been the key driver of overall growth – a trend that is likely to continue going forward.

"The availability of credit and affordability of vehicles is a winning combination for auto sales in 2016," said Andrew Stuart, President and CEO of TD Auto Finance. "With the current state of the economy, buying a car is now more attractive than ever, making it an exciting time to be in the automotive finance industry."

Ongoing job creation is projected to bring the unemployment rate down to 4.6 percent by the end of next year, while employment income growth is likely to remain above 4 percent. Combined with rising wealth stemming from a recovery in the housing market and stronger household balance sheets, consumers will be well positioned to loosen their purse strings and consider purchasing big-ticket items such as autos.

Consumer automobile buying patterns impacted by financing

The low cost of credit, longer loan terms and the rise in leasing have all worked to lower monthly payments, making the purchase of a vehicle less of a financial burden for consumers. Interest rates on 48-month new car loans are hovering around record lows of about 4 percent, while the average loan length increased to 67 months in the fourth quarter of last year.

Average transaction prices have also been rising – up 2.2 percent in 2015. However, this is not entirely due to higher price tags. The shift in demand toward luxury vehicles and light trucks – with crossover SUVs and pick-up trucks recording the largest increase last year – means that consumers have been purchasing more expensive vehicles, which will ultimately raise the average price paid. Without the extension in loan terms, leasing and low interest rates, consumers may have instead opted for smaller, more affordable vehicles, according to the report.

Industry facing headwinds that will take some steam out of sales

While currently at a healthy level, sales will begin to level off as pent-up demand has largely been absorbed, the consumer buying cycle is being stretched out, the vehicle ownership rate is expected to decline and competition from the used car market is expected to take some steam out of the market. Indeed, drivers appear to be holding onto their vehicles for longer, and recent trends – including a shift in lifestyle preferences and car sharing – suggest that ownership rates could decline.  Moreover, an influx of young, used vehicles set to hit the market will provide consumers with more options when purchasing a vehicle.

Disruptors disrupting

Self-driving vehicles, one of the largest disruptors in decades, could change the entire landscape of the market. As prototypes for autonomous cars evolve and move closer to adoption, this yet unregulated area could pose additional complexities for the industry. Still, recent and forthcoming disruptors could be a positive for auto sales in the future, particularly those related to 'connected' vehicles, as staying connected at all times has become a way of life for many consumers – especially millennials. Automakers cannot become complacent in this rapidly changing environment, where disruptors will continue to be a key element of the market, intensifying competition, TD Economics advises.

Bottom line

Auto sales are expected to remain around the 17 million unit mark for some time. However, a longer-term norm for sales is likely closer to the mid-16 million unit range, as the recent trek above 17 million is still satisfying demand that was built up during the recession. Automakers must anticipate such a move to more sustainable levels and manage this transition in a way that doesn't lead to a sharp correction in sales.