By Ray Birch
DALLAS—As the terms on auto loans reach record lengths, the result is often greater negative equity in vehicles, and that could mean problems for both borrowers and lenders in the years ahead, analysts are warning.
What is adding to concerns is that at the same time terms are extending, so too is consumers’ desire to turn in their cars every three years to take advantage of new technology that can quickly make a new car seem obsolete, leaving little time to reverse an upside down equity position.
Average terms have extended for each of the past five years, while the average transaction price on new cars has reached a record high—over $27,000—noted Brian Turner, executive director with Meridian Alliance.
“Not only does this extend average loan lives from two to over three years, it comes during a time of relatively low short-term interest rates—something that has held down average asset yields over the past six years,” Turner said.
Underwater With Financing
What is especially concerning, said Turner, is the percentage of car owners facing negative equity is projected by J.D. Power to hit a 10-year high in 2016. At 31.4%, nearly one-third of all car owners are currently underwater with their financing.
Brian Turner, Meridian Alliance
“This is higher than in 2006 when the percentage of underwater ownership was 19.6% when, as J.D. Powers points out, ‘Easy credit temporarily juiced sales before the industry crashed.’”
Bill Handel, SVP of research at Raddon Financial Group in Lombard, Ill., noted that as borrowers get more upside down, it’s is a sign lenders are reaching deeper down into the credit pool. Both of those scenarios–greater negative equity and more subprime borrowers–pose a greater risk to lenders if the economy turns down, he reminded.
The only silver lining: “One advantage is that cars are lasting longer,” said Handel.
Tech Driving Cost And Trade-Ins
But many auto experts have stated that new technology is not only driving up the price of cars and extending terms, it is also increasing the desire among many consumers to trade their cars in sooner to keep up with the advances.
“It can be a Catch-22 situation,” said Handel.
Melinda Zabritski, senior director of automotive finance for Experian Automotive, Schaumberg, Ill., emphasized that the concern with longer-term loans is often consumers not wanting to hold onto the car long enough to get out of a negative equity position.
“Trade the car in at 30 to 32 months and chances are the borrower will be upside down,” said Zabritski. “Then that negative equity gets rolled into the next loan and the person’s financial problems are only exacerbated. It creates a cycle of increasing negative equity. At some point the consumer needs to bring cash into the transaction—and they need to bring more than money for tax, title and license. Today, 10% down barely covers those things.”
Zabritski said the concern is not only for borrowers’ personal balance sheets but also for lenders if they have to repossess an upside down vehicle.
Melinda Zabritski, Experian
“Especially in today’s market where wholesale values are coming down as inventory is being built up by many cars coming back to the used market,” said Zabritski.
Double Whammy
Zabritski added that consumer balance sheets sometimes experience a double whammy when they roll negative equity into their next car loan—not only facing a longer period to get right-side up, but also saddled with a rate that is one to two percentage points higher than they would have received had the negative equity not been carried over.
Despite the potential problems from longer terms, Zabritski said lenders appear to be making these loans largely to prime borrowers.
“The scores we are seeing on the longer-term loans, 73 to 84 months, are pretty stable,” she said. “Right now we are not seeing loan performance degrade on the longer-term loans.”
Zabritski noted that the average term for new cars through 2015 was 67 months, up one year from 2014. The used average is 63 months, up from 62 months midway through 2015.
She also pointed out that credit unions tend to offer longer terms than any other lender, edging out banks and finance companies on 73 to 84 month loans and clearly standing out as the leader in offering loans of 85 to 86 months.