Though U.S. auto sales have slowed a bit in recent months, the American market seems all but certain to set a new record again this year, the third consecutive all-time high.
So why does that worry many industry experts? Because a growing number of car buyers are stretching their budgets with some of the longest loan terms ever offered, something one senior industry executive calls “a formula for disaster.”
A new study by TransUnion shows that the average auto loan is now on the books for 67 months, up from just 62 months at the beginning of the decade. And the report reveals that the number of loans running anywhere from 73 to 84 months has more than doubled since 2010.
“In recent years, longer-term auto loans have grown in popularity as consumers aim to keep monthly payments at a certain threshold,” said Jason Laky, senior vice president and automotive business leader for TransUnion.
(New car sales regained momentum in June. Click Here for more.)
The increase in longer loan terms has come at a time when consumers are spending more than ever on their new cars and light trucks. Industrywide, auto sales revenues hit a record $50.9 billion in June 2016, with average transaction prices – what consumers actually pay for a vehicle – up 1.9% year-over-year – to $32,693, according to tracking firm TrueCar.
Automakers have, in many cases, been taking steps to maintain market momentum, offering bigger incentives, subsidized loans and leases and stretching out loan terms to draw in those who might have trouble squeezing a new vehicle into the household budget.
“Longer auto loan terms allow consumers to keep payment levels reasonable as they finance more expensive vehicles,” said Jason Laky, senior vice president and automotive business leader for TransUnion. “However, consumers who cannot afford the monthly payment on a shorter term for the same loan are riskier, and we see this manifested in the higher delinquency rates for 72- and 84-month loans.”
Significantly, 30.7% of those shoppers with subprime credit ratings who have opted for loans of 73 to 84 months were delinquent on their payments. By comparison, only 22.4% of subprime borrowers with 49 to 60-month loans had fallen behind by at least 60 days.
But, even among buyers with good credit ratings, delinquency rates rose rapidly the longer the loan terms. Among those with prime credit, delinquency rates were just 3.4% for the 49 to 60 month loans, more than doubling to 7.1% on loans of at least 73 months. Even with so-called super-prime buyers, delinquency rates shot up 450%, to 1.8% on the lengthiest loans.
Longer-term loans have been “growing and growing and growing,” and that’s a serious concern the industry needs to address, said Robert Davis, head of U.S. operations for Mazda. It is “just a formula for disaster going forward,” he warned, and something that is “getting a little concerning to us.”
Davis and some other industry observers point to the way automakers and lenders loosened credit in the years leading up to the Great Recession that send two Detroit companies into bankruptcy. The financial community responded by all but shutting off the loan spigot during the middle of the recession. Even some customers with super-prime ratings were temporarily denied financing on new vehicles.
(But are U.S. car sales about to peak for the current cycle? Click Here for the story.)
On the positive side, the new TransUnion study finds that even though loan terms are growing longer, the time consumers actually spend with those loans outstanding has declined. In other words, a growing number of car buyers are paying them off sooner. There are a number of reasons why, including earlier trade-ins or a desire to simply pay off the loan ahead of time.
Ironically, that’s not necessarily good news, either, said TransUnion’s Laky, “because as borrowers remain in their auto loans about one month less, lenders may not be capturing the benefits of more payments and greater interest income they might expect from longer-term loans.”
(New study says three of four American motorists want autonomous vehicles. Click Here for more.)