Auto Loan Risks 1.0
This the first part of an editorial on the factors involved in the US new vehicle market. The issues addressed will be 1) Increasing length of loan terms, including reason and potential effects. 2) The status of interest rates associated with vehicle lending. 3) Attempting to forecast the results which will be recognized by 2021.
First we need to understand the importance of the auto industry in the US. There are millions of jobs associated with the industry and many of which that currently have or will have their retirement income dependent on the industry. The damages that could occur economically from one or more of the big US manufacturers, was apparent to the federal government, evidenced by the large “bailout” that occurred a few years back. It was the Fed’s belief that their role as the “lender of last resort” was appropriate.
In a story posted on January 22, 2015 by Ryan Beene on autonews.com titled ‘Why the 72-month auto loan isn’t causing jitters – yet’, summarized as follows: “If lenders made assumptions about asset values and took advantage of low interest rates to offer friendlier loan terms so borrowers could more easily finance purchases they wouldn’t be able to afford otherwise? One risk is another 2008, when the U.S. housing market, propped up by creative mortgages, collapsed in spectacular fashion, sending shock waves across the global economy. Another scenario is the one now playing out in the auto market, where, despite stagnant personal incomes, the auto industry is able to command both rising sales & higher transaction prices by extending loan terms to five, six and even seven years, making monthly payments more manageable. The abundance of extended-term financing could cause a future slowdown in the auto market as shoppers ride out longer loan terms before returning to the market. But for now, they see that risk as limited. Executives say that strong used car values, low interest rates & automakers’ discipline in managing production and incentives point to a more sustainable recovery in auto sales and lending, even as consumers increasingly opt for car loans that will take more than half a decade to repay.
New-car loan terms are lengthening as consumers try to keep monthly payments affordable.
Q1 AVG. Loan term
- 2014 66 months
- 2013 65 months
- 2012 64 months
- 2011 63 months
- 2010 62 months
- 2009 62 months
- 2008 60 months
The average term of new-car loans in the 1st quarter of 2014 was 66 months, up one month from the prior year and the longest average term Experian Automotive has on record. At the same time, loans with more than 5-year repayment terms accounted for 66% of all new-car loans. Loans ranging from 73 to 84 months jumped 28 percent in the first quarter, accounting for a quarter of all new-car loans, according to Experian, while loans ranging from 25 months to 72 months declined. Longer loans also enable customers of all credit profiles to obtain lower monthly payments. This growing segment of buyers will delay their next vehicle purchase until their 6-or 7-year loans are repaid, slowing the replacement cycle & bringing the current sales recovery to a crawl.
Customer equity is being protected in part because manufacturers are tailoring production to meet demand, boosting resale values. That, plus low interest rates, helps customers reach equity in their vehicles more quickly. Lenders & dealers have become more sophisticated in figuring out when to pitch borrowers on turning that equity into trade-in currency.”
Dealer Sales Tactic
The discussion on the length of term among auto loans is based on a fundamental. The dealer needs to sell cars and is dependent on finding a way for their customer to feel comfortable signing for a deal. The tactic used at the dealership is TO FOCUS ON THE MONTHLY PAYMENT. Once the salesperson determines a monthly payment range that the customer desires (or can afford), then the variable becomes the term. For example, a $25,000 vehicle calculated at an 8% interest rate for 60 months is roughly a $506 monthly payment for the customer. If the dealer slides that term to 72 months then the monthly payment is a more comfortable $438 payment. The longer the length of the loan, the more likely it is that the customer may default. Currently the warranty on the Chevy Cruze for major powertrain components is 5 years or 100,000—whichever comes first. If the engine goes dead, needing $1,800 in repairs in month 61 of a 72 month loan, the owner, who likely is unable to save money since their income has not risen (as has been the case in US wages over the last 5 years) will rely on whatever available credit they have available for the repair and potentially slip into a possible default on the loan. Another scenario is how likely is the buyer to experience a period where they become unemployed over a 6 year span? Hopefully this sheds some light on the pending problem.
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