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It’s Not Just Pricing, Auto Loans Are Also Getting Out of Hand

As you’re undoubtedly aware, now isn’t the best time to purchase a new vehicle. While you can currently sell your ride for more than it’s realistically worth, the economy is anything but stable as inflation and supply shortages gum up the works. A lack of semiconductor chips has caused the automotive industry to stutter endlessly throughout 2021, with the issue getting so bad that some manufacturers have been building unfinished vehicles just to give their employees something to do. Ford is even mulling over a strategy to ship those units directly to dealerships so they’ll have something on the lot — effectively making its retail network responsible for final assembly.

But the logistics nightmare is only part of the story. Automotive loans are also becoming untenable as terms stretch out endlessly. Cars continue getting more expensive and the average consumer is losing their buying power. The preferred solution is for financiers to extend agreements so customers can continue making the same monthly payments while accruing more on interest over the duration. While effective in the short term, and bound to make banks money as we’re all driven deeper into debt, one wonders how this plays out on a grander scale. 

History would suggest rather poorly.

America’s last big recession wrapped in 2009 and was preceded by swelling prices and lengthening loans. But the average terms on a new vehicle had been tamped back down to 63 months by 2010. They’ve been climbing back up ever since and are now surpass 70 months. According to the U.S. Department of Labor, used automobiles were 45 percent more expensive in June 2021 than they were in June 2020 while new cars saw an almost 6 percent increase over the same timeframe. But businesses have managed to keep monthly payments from getting out of hand by extending terms. You’re still paying more overall, but you’ll feel less of a sting every four weeks.

Blame COVID restrictions, increased regulatory pressure, predatory lending tactics, a chip shortage created by mismanagement/our own obsession with electronic devices, and the industry burning tons of money in service of chasing down electrification and the nebulous concept of “mobility.” They’re all to blame but the economy has also taken a pretty savage turn in general and it’s making a lot of people nervous about the future, including The Wall Street Journal.

The outlet recently published a study noting that this change has been particularly hard on the bottom rung of our economy. Longer duration loans are being offered to subprime borrowers and ultimately results in their paying more for the same product than someone who could afford to place more cash on the table and make larger monthly payments. However, the subprime and deep subprime segments now appear to be abandoning the market altogether.

From WSJ:

A 2018 analysis from Moody’s Investors Service showed that the cumulative losses of longer-term prime auto loans (those 72 months or longer) originated between 2003 and 2015 were two to five times higher than shorter-term loans originated during the same period. That is partly because longer duration loans tend to go to less creditworthy borrowers, according to Moody’s. Credit profiles of car buyers do look better today and consumers have more saved up thanks to stimulus payments and spending less during pandemic lockdowns. The average credit score for both new and used car buyers has increased since 2016, according to Experian. The share of prime lending has also increased over that period, while subprime lending is near record lows.

The flush bank accounts of car buyers is helping some of them make deals involving more cash. Loan-to-value ratios for car loans have “come in better as people are putting in more cash on the deals,” Santander Consumer USA Holdings’ chief financial officer, Fahmi Karam, said on the lender’s earnings call in April.

High used-car prices have also meant that lenders could command higher prices for the repossessed cars when loans default. Auto defaults were at a 10-year low as of May 2021, according to the S&P/Experian Auto Default Index. Recovery rates for auto asset-backed securities reached all-time highs in April, with prime recoveries rising above 100 [percent], according to S&P Global Ratings. Declining car prices will likely have the opposite effect.

But the outlet remains generally optimistic, suggesting that the swap to trucks and crossovers means the average automobile will be better at holding its value. Vehicles are also being retained longer than ever before, with the average age of roadworthy light vehicles now surpassing 12 years. While we would like to attribute that entirely to the industry providing increasingly durable cars, U.S. sales growth has been trending in the wrong direction — much like it did ahead of the Great Recession.

With Americans buying fewer cars per year, it’s not surprising to see the average vehicle age increase. It’s also not necessarily indicative of modern automobiles being more robust, though that likely plays a factor. Many are undoubtedly holding onto vehicles longer now that buying something else is becoming prohibitively expensive for a subset of the population. The middle class was already shrinking in this country, with the last couple of years representing the greatest upward transfer of wealth in modern history. Adding a few hundred more billionaires to the roster means a few thousand more six-figure automobiles get sold. But culling the wealth of millions of middle-class consumers means many of them have to pass on buying the vehicles that actually keep the industry humming.

[Image: Pathdoc/Shutterstock]




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