Keep those car payments low! That is what we Americans must be telling ourselves, if the latest Experian State of the Automotive Finance Market report is any indication. The typical way to keep a car payment as low as possible is to stretch out the loan terms in years, forcing you to pay more in interest over the long haul but giving you a more manageable monthly payment. The Experian report shows that we are in uncharted waters with extended loan terms.
Car buyers are stretching out their loan terms to record levels, with the average term for a new car loan at 67 months and the average used car term right behind at 62 months. The average is being skewed by an increasing number of long-term loans of between 73-84 months in term. Almost 30% of all car loans financed during the first quarter of 2015 fall into that 6-7 year category. That represents a 19% increase from a year ago and is the highest value since recordkeeping on such loans began in 2006.
Combine this with records in the average amount financed and the average monthly payment, and we have an economic dilemma. Improved car sales are certainly an economic growth driver (no pun intended). Manufacturers, dealers, lenders, and support personnel all benefit from increased sales income — but is this coming at the expense of consumers?
Consumers who are overextended may face repossession with any financial setback, and an extended loan term makes that more likely to happen. Meanwhile, to attract business during difficult times, lenders have been increasingly approving subprime loans and stretching credit limits. The market seems to be readily absorbing these subprime loans despite investigations by the Securities and Exchange Commission (SEC) and other regulatory agencies.
Consider that Structured Finance News reported that Santander Consumer USA, a major clearinghouse for auto loans, sold off $700 million in subprime loans in a matter of hours, even though the borrower's average FICO score was 552 and 13% of borrowers had no credit score at all. Julie Menin, the Commissioner of New York City's Department of Consumer Affairs, said that subprime auto loans "are growing at a staggering rate of more than 130% since the financial crisis."
Sound familiar, anyone? Think potential mortgage crisis on wheels.
This all may mean nothing, if consumers wisely hang onto their cars and either make an occasional extra payment against principal or pay the car off before the long term. Generally, real life tends to go in the opposite direction and people end up getting rid of the car before the loan is paid off — often rolling the debt into the next car purchased and continuing the downward spiral.
In the worst case, consumers are not able to spend as their debt rises, repossessions skyrocket, the auto market seizes up and the overall economy stalls. The effect probably would not be as severe as the mortgage crisis, but the economy certainly does not need any more setbacks in the midst of a slow recovery from the last crisis.
If you are an investor, this suggests that there is still money to be made in investing in the auto companies as well as in holding consumer auto debt, but keep in mind that the risk is also going up with the reward. People made lots of money in mortgage-backed securities — right up until the bubble burst and the mortgage crisis began.
Keep your risk tolerance in mind and use common sense as you invest. You probably should also keep track of the news regarding subprime auto loans, the regulatory investigations, and the monthly auto forecasts.
Arguments rage about whether we are in an auto-loan bubble now, and there is certainly some evidence suggesting that we are, but remember that you can only define a bubble after it has popped.