Auto loans think outside the box
Prices for new and used vehicles are reaching record highs, supported by a semiconductor shortage that has limited auto production as consumers eager to get out and buy them. Used cars and trucks were 45.2% more expensive in June than they were a year earlier, while new cars were 5.3% more expensive, according to the Labor Department. Monthly payments don’t seem that different to consumers, however, thanks to lower rates, longer terms, or more money. For new cars, average monthly loan payments only increased by $ 7 in the first quarter of 2021 compared to the previous year, according to consumer credit reporting company Experian..
During the same period, monthly used car loan repayments increased by $ 19, or 5%.
Loan terms were getting longer even before the pandemic. The average length of an auto loan was 70 months for new cars and 68.9 months for used cars in the second quarter, according to data from Edmunds; 10 years ago, they lasted an average of 64 months and 62 months, respectively. Much of this happened as competition intensified among lenders and car prices gradually increased, with automakers adding new technology and customization options to vehicles. Longer payment terms were designed to make vehicles more affordable.
There are reasons for both consumers and lenders to be wary of long-term loans. For consumers, an obvious problem is that you usually end up paying more interest over the life of the loan. Another is that you could end up owing more than the car is worth. This latter concern is particularly relevant today, as high car prices will eventually fall back to earth when the supply crunch for new cars subsides. This means that if a consumer tries to sell the car or if it is totaled in an accident, money from a buyer or insurance company might not cover the loan balance.
A 2018 analysis from Moody’s Investors Service showed that the cumulative losses of longer-term prime auto loans (those of 72 months or more) created between 2003 and 2015 were two to five times greater than shorter-term loans. term created during the same period. This is in part because longer-term loans tend to go to less creditworthy borrowers, according to Moody’s. The credit profiles of car buyers are brighter today, and consumers have saved more through stimulus payments and are spending less during pandemic lockdowns. The average credit score of new and used car buyers has increased since 2016, according to Experian. The share of prime loans has also increased during this period, while subprime loans are near their all-time low.
The empty bank accounts of car buyers help some of them to close deals involving more money. Loan-to-value ratios for auto loans have “improved as people invest more money in transactions,” said Fahmi Karam, chief financial officer of Santander Consumer USA Holdings, on the lender’s earnings call in April.
The high prices of used cars also meant that lenders could charge higher prices for repossessed cars in the event of default. Automatic defaults were at their lowest level in 10 years in May 2021, according to the S & P / Experian automatic default index. Auto asset-backed securities recovery rates hit all-time highs in April, with recovery rates above 100%, according to S&P Global Ratings. Falling car prices will likely have the opposite effect.
The severity of this reversal is an open question, and one that lenders will need to ask themselves as competition intensifies between them, possibly resulting in even longer terms and lower rates. Donald Fandetti, analyst at Wells Fargo, says competition is intensifying for auto loans as banks struggle to find good ways to run huge inflows of deposits.
There is reason to believe that the eventual drop in the market value of cars, new and used, might not be so steep. Jessica Caldwell, industry analyst at Edmunds, says SUVs and trucks recently preferred by consumers tend to lose less value than passenger cars over time. This is especially true for vans, which tend to be used for practical purposes and are still in high demand. The eventual introduction of a new vehicle inventory is likely to be a “runoff, not a flood,” which should also reduce the downward pressure on car prices, she added.
And although vehicles depreciate, advancements in technology have helped extend their useful life. the middle age The number of cars and light trucks in circulation in the United States has risen to 12.1 years this year, according to IHS Markit, from 9.6 years in 2002.
A sudden reversal in the direction of car prices could come as a shock to consumers and lenders. But abundant stimuli, bigger wallets, and longer car life should serve as airbags for any accident along the way.
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