"Underwater" Auto Financing

Vicious cycle of negative-equity deals

Roger Davis
June 15, 2017 - 2:13 pm

Auto industry watchers are frowning at the amount of "upside-down" car financing they're seeing lately.  Autoweek reports that in the first quarter of this year, the percentage of trade-ins on new-vehicle sales that had negative equity reached a record 32.8 percent. The average amount of negative equity, nearly 52-hundred dollars, is also a new high.  It's a triple-whammy of longer-term loans, rising prices and falling used-vehicle values...and it's taking a toll on consumers as well as the automotive industry. Despite carrying loans that can extend to the better part of a decade, a lot of people still trade every few years, a cycle that will continue to generate record levels of underwater deals.

From 2009-11, negative equity fell "simply because people couldn't get a new-car loan," Edmunds data analyst Ivan Drury said.  As vehicle financing dried up during the downturn, many consumers were forced to hold onto their vehicles, so they paid down more of their balance. "When they finally went to the dealership," he said, "they didn't owe nearly as much."

Now that most consumers have recovered from the recession, they are more likely to trade in their vehicles earlier, often before their loan terms expire. The practice contributes to higher amounts of negative equity.

Consumers are stretching their loan terms as they strive for the lowest possible monthly payment. The average new-vehicle loan term in the first quarter was 69 months, up five months from the first quarter of 2011, Edmunds data show.

'Vicious cycle'

Loans lasting 73 to 84 months have also increased, according to Experian, making up 32.1 percent of new-vehicle loan share in the fourth quarter of 2016, compared with 29 percent a year earlier. On the used-vehicle side, loans lasting 73 to 84 months accounted for 18 percent of the share, up from 16 percent a year earlier.

Moreover, there has been upward movement within the 73-84-month loan segment, according to Melinda Zabritski, senior director of automotive finance at Experian. "Years ago, when you saw lenders starting to move into that category, they were on the low end of it," between 73 and 75 months, she said. "Now we're seeing a shift within that category of more loans truly being written at 84."

"Think about the way the principal and the interest accumulates over a 60-month loan, or a 66 or 72 (month) loan," said Cheryl Miller, vice president of lender solutions at Dealertrack. "The equity the consumer is building from a principal perspective is (lower) than it is on a shorter duration loan."

If consumers are accustomed, say, to a five-year trade-in cycle but extend their term to six years and beyond to keep the monthly payments low, they are "getting caught in this vicious cycle," Drury said.

Read more: http://autoweek.com/article/car-news/why-car-buyers-are-underwater-loans...

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