Experts warn against long-term auto loan trend
After a year of record new-vehicle sales, automakers, dealers and the banks and finance companies that issue car loans are jubilantly exchanging high-fives.
Analysts list several reasons for record sales of 17.Five million vehicles in 2015, including an improving economy and job market, low interest rates, cheap gas and growth in leasing.
New-car sales also are being driven by effortless credit: Consumers, many with marginal credit ratings, are borrowing higher amounts and for longer loan terms than ever before. Experian, one of the three major credit bureaus, says that the average loan for a fresh vehicle in the third quarter was $28,936, up by more than $1,100 from a year earlier, and the average loan was for sixty seven months.
What’s more, consumers are attempting to keep monthly payments affordable by spreading out the payments. Seventy-one percent of new-vehicle loans were for longer than five years and almost thirty percent were longer than six years. . In addition, twenty nine percent of fresh vehicle loans were issued to borrowers with credit scores below prime (660 or lower).
Potentially millions of consumers will owe more than their vehicle is worth for years and will still be making payments after the warranties run out. When they get the new-car itch again, they might have little or no equity in the vehicle they want to trade in.
Few within the auto or banking industries express concern about these trends, but others warn that liberate credit that puts consumers in hock longer and for higher amounts could backfire in the future, especially if there is an economic downturn.
Among those swinging a caution flag is Thomas J. Curry, comptroller of the currency, head of the federal agency that regulates banks. In an October speech to financial services executives, Curry warned that longer loans are “exposing lenders and investors to higher potential losses.”
“Albeit delinquency and losses are presently low, it doesn’t require good foresight to see that this may not last. How those auto loans, and especially the nonprime segment, will perform over their life is a matter of real concern to regulators. It should be a real concern to the industry,” he said.
New-car sales have bounced back since the recession to levels not seen since 2007, and a significant portion of that rebound is due to a record number of vehicles being leased.
Twenty-six percent of fresh vehicles in the 2nd quarter were leased, Experian Automotive data demonstrate. That is almost dual.
New-car sales have bounced back since the recession to levels not seen since 2007, and a significant portion of that rebound is due to a record number of vehicles being leased.
Twenty-six percent of fresh vehicles in the 2nd quarter were leased, Experian Automotive data showcase. That is almost dual.
Melinda Zabritski, senior director of automotive financial solutions for Experian, argues that delinquency rates on auto loans are lower now than before the recession
In the third quarter of 2007, Two.81 percent of auto loans were thirty days past due. In two thousand fifteen it was Two.53 percent. The 60-day delinquency rate is virtually the same at less than one percent. Subprime borrowers — those with credit scores below six hundred — take out a smaller chunk of auto loans today than in 2007, twenty four percent instead of twenty eight percent.
“In today’s market we’re pretty much where we were back pre-recession. The level of subprime borrowing is even a little more conservative than it was pre-recession,” Zabritski said in a telephone interview, adding that most subprime customers pay on time. “Just because you’re subprime doesn’t mean you’ll absolutely go delinquent.”
Loans are getting longer because car shoppers are watching higher sticker prices on fresh vehicles — and more are opting for high-end models loaded with expensive features.
“Because cars cost more, consumers need to finance more of the vehicle in order to make that purchase, and that drives the monthly payment up,” Zabritski said.
“Most people who are buying a car are attempting to negotiate monthly payments. If you can’t put more money down, and you’re increasingly having higher vehicle cost, the only way to keep that payment modest is to thrust out the term.”
Greg McBride, chief financial analyst for Bankrate.com, said there is another way, but it’s one that many consumers don’t want to hear: Buy a cheaper car.
“If you’re buying a fresh car and the loan goes beyond five years, you’re buying too much car. On a used car, don’t go beyond four years,” McBride said in a telephone interview, adding that too many consumers concentrate on the monthly payment instead of the total cost.
“That’s detrimental to your financial health. It’s financial engineering; the dealer can spread out the loan term to squeeze that monthly payment into your budget. When people shop for a monthly payment, they’re not focusing on the total cost,” McBride said.
For example, spreading a $500 monthly payment over seven years instead of five increases the total cost by $12,000. Worse, the vehicle’s value will decline swifter than the principal balance.
“Automobiles are depreciating assets, and the longer you spread out that loan term, not only does that mean your interest (cost) grows, but you spend more time being upside down,” he said.
The concentrate on monthly payments has also contributed to the growth in leasing, McBride said. Experian says that twenty seven percent of fresh vehicles were leased instead of purchased in 2015, up from eighteen percent in 2010. A key reason is that the average lease payment last year was $398 versus $482 for the average new-car payment. Another reason is that leasing is touted as a way to drive a more-expensive car than a consumer could afford to buy.
That’s loser’s gold, McBride warns.
“There’s no free lunch; the trade-off is that at the end of the lease you don’t own it. You palm the keys back and begin all over,” he said. “You don’t get rich by driving expensive cars.”
He offers this “harsh love” advice:
“Look at the total cost. Don’t look at what you can afford based on a monthly payment alone. Shop around for your financing because there’s a vast disparity in rates available on loans. The best rates are below two percent, but you could lightly pay twelve percent,” he said. “And negotiate the price of the car separate from the financing.”
Rick Popely is a freelance reporter.