Car loans are spiraling out of control

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Prices for new and used cars are shown at record highssupported by semiconductor power crunch this is holding back car production while consumers are eager to go out and shop for them. Used cars and trucks accounted for 45.2% more expensive in June according to the Labor Department from a year earlier, and new cars were 5.3% more expensive. However, monthly payments are not all that different for consumers due to lower rates, longer terms, or more cash. Average monthly payments on new car loans in the first quarter of 2021 increased by just $ 7 from a year earlier, according to a consumer lending company.

Experian

Monthly payments on used car loans increased by $ 19, or 5%, over the same period.

The loan term was getting longer even before the pandemic. According to Edmunds, the average car loan term in the second quarter was 70 months for new cars and 68.9 months for used cars; 10 years ago, they averaged 64 and 62 months, respectively. Much of this happened as competition between lenders increased and car prices gradually rose as automakers added new technology and vehicle customization options. Longer payment terms have been designed to make cars look more affordable.

There is a reason – for both consumers and lenders – to be wary of long-term loans. For consumers, one obvious snag is that you tend to pay more interest over the life of the loan. Second, you may be in debt more than the car is worth. The latter concern is especially true today, because sky-high car prices will eventually hit the ground as demand for new cars wanes. This means that if a consumer is trying to sell a car or if it has an accident, money from the buyer or insurance company may not cover the loan balance.

A 2018 analysis by Moody’s Investors Service found that the cumulative losses on long-term premium car loans (72 months or more) received between 2003 and 2015 were two to five times higher than short-term loans issued that year. same period. This is partly due to the fact that longer-term loans tend to be made to less creditworthy borrowers, according to Moody’s. The credit profiles of car buyers are looking better today, and consumers have saved more through incentive payments and spend less during the pandemic lockdown. According to Experian, the average credit rating of both new and used car buyers has increased since 2016. The share of first-class lending also increased during this period, while sub-prime lending is at an all-time low.

The clean bank accounts of car buyers help some of them make deals that involve more cash. The credit-to-value ratio for car loans “has improved as people put more money into deals,” Santander Consumer USA Holdings Chief Financial Officer Fahmi Karam said in the lender’s April profit and loss statement.

High prices for used cars also meant that lenders could charge higher prices for seized cars in the event of default on loans. According to S & P / Experian Auto Default Index… According to S&P Global Ratings, the return rate of asset-backed securities hit record highs in April, with initial returns exceeding 100%. Lower car prices are likely to backfire.

How serious this reversal will be is an open question, and lenders will have to ask themselves this question as competition between them grows hotter, possibly leading to even longer terms and lower rates. Donald Fandetti, an analyst at Wells Fargo, says competition for auto loans is intensifying as banks struggle to find good ways to tap into huge inflows of deposits.

There is reason to believe that the potential decline in the market value of cars, new and used, may not be as dramatic. Jessica Caldwell, an industry analyst at Edmunds, says SUVs and trucks that have recently become popular with consumers lose less value over time than cars. This is especially true for pickup trucks, which are usually used for practical purposes and are always in high demand. Ultimately, she added, the introduction of new vehicles will be “a trickle, not a flood,” which should also ease downward pressure on car prices.

And while cars do depreciate, technological advances mean they have a longer useful life. IN average age The number of passenger cars and light trucks in service in the US has grown to 12.1 years this year, according to IHS Markit, from 9.6 years in 2002.

A sudden change in the dynamics of car prices can shock consumers and lenders. But abundant incentives, fatter wallets, and longer vehicle lifespan should act as airbags for any accidents along the way.

Write to Jinju Lee in jinjoo.lee@wsj.com and Telis Demos in telis.demos@wsj.com

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