Prices for new and used vehicles are at record highs, buoyed by a semiconductor supply crisis that has kept a ceiling on car production just as consumers are eager to get out and buy them . Used cars and trucks accounted for 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 look all that different to consumers, though, thanks to lower rates, longer terms, or bringing in more cash. For new cars, average monthly loan repayments rose just $7 in the first quarter of 2021 from a year earlier, according to consumer credit reporting firm Experian..
Used car loan payments increased by $19, or 5%, over the same period.
Loan terms were getting longer even before the pandemic. The average auto loan term was 70 months for new cars and 68.9 months for used cars in the second quarter, according to Edmunds data; 10 years ago, they averaged 64 months and 62 months, respectively. Much of this happened as competition grew among lenders and car prices gradually rose as automakers added new technologies 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 longer-term loans. For consumers, an obvious catch is that you usually end up paying more interest over the life of the loan. Another is that you might end up owing more than the car is worth. This last concern is particularly relevant today, as exorbitant car prices will eventually come down to earth once the new car supply crisis eases. This means that if a consumer tries to sell the car or if it is destroyed in an accident, the money from a buyer or an insurance company might not cover the loan balance.
A 2018 Moody’s Investors Service analysis showed that cumulative losses on longer-term prime auto loans (those 72 months or more) taken out between 2003 and 2015 were two to five times higher than short-term loans. contracted during the same period. That’s partly because longer-term loans tend to go to less creditworthy borrowers, according to Moody’s. Car buyer credit profiles look better today and consumers have saved more from stimulus payments and spent less during pandemic shutdowns. 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 over this period, while sub-prime loans are near record highs.
Car buyers’ empty bank accounts are helping some of them close deals involving more money. Loan-to-value ratios for auto loans have “improved as people put more money into deals,” Santander Consumer USA Holdings chief financial officer Fahmi Karam said on the earnings call. lender in April.
High used car prices have also meant that lenders could charge higher prices for repossessed cars in the event of default. Auto defaults were at their lowest level in 10 years in May 2021, according to the S&P/Experian automatic default index. Recovery rates for auto asset-backed securities hit all-time highs in April, with recovery rates exceeding 100%, according to S&P Global Ratings. Lower car prices will likely have the opposite effect.
The severity of this reversal is an open question, which lenders will have to ask themselves as competition between them intensifies, which could lead to even longer terms and lower rates. Donald Fandetti, an analyst at Wells Fargo, said competition is heating up for auto loans as banks scramble to find good ways to capitalize on huge deposit inflows.
There is reason to believe that the eventual decline in the market value of cars, both new and used, may not be as steep. Jessica Caldwell, industry analyst at Edmunds, says SUVs and trucks recently favored 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 always in high demand. The eventual introduction of new-vehicle inventory will likely be a “trickle, not a flood”, which should also reduce downward pressure on car prices, she added.
And although vehicles depreciate, advances in technology have meant they have a longer useful life. the middle age The number of cars and light trucks on the road in the United States rose 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 shock consumers and lenders. But plentiful stimuli, bigger wallets and longer car lifespans should act as airbags for any mishaps along the way.
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Appeared in the print edition of July 17, 2021 under the title “Car loans take a long, long way”.