As far as my kids are concerned, being underwater equates to summer fun. However, underwater auto owners aren’t having fun when they discover they owe more on their trade-in than its worth.
Why are so many motorists underwater? Negative-equity levels are at record highs as longer loan terms, rising transaction prices and falling used-vehicle values combine to take a toll on consumers and the industry.
A friend of mine currently has two vehicles that he is financing. He moved to a new state and realized after living there through the winter that he needs a 4WD pickup truck. He went to the dealership to look at a new vehicle and had the rude awakening that he is upside down in not one, but both of his current autos. A few years ago he had signed at a longer term (which equaled a lower monthly payment) so that he could have more cash on hand as a lesson from the Great Recession. Although that has now caused him to be in a loan where his current vehicle’s value is far less than what he actually still owes on it. Unfortunately, he is not the only one that this is happening too.
I was in the auto finance industry for over 18 years, mostly on the indirect lending side. There were many applications I reviewed where negative equity was a factor, but not at the levels they are in the current market. It seems negative equity has hit all-time records in 2017. Data from Edmunds shows that in Q1 2017, the percentage of trade-ins with negative-equity totaled 32.8% with an average dollar amount of $5,195. If you owe more on your current vehicle than it is worth and you roll the balance of your existing auto loan into your new auto loan, this will make the new auto loan much more expensive. Your total loan cost will be higher because you will be borrowing more than just the price of your new vehicle. By rolling negative equity into a new auto loan, consumers are getting into a cycle that can be very tough to recover from. The trade-in cycle doesn’t always match loan terms so they end up underwater.
The disconnect between vehicle price and affordability.
The average price tag on a new car is unaffordable for median-income households in 24 of the 25 largest U.S. metro areas, according to a Bankrate.com study. Don’t get me wrong, we all like to enjoy the good things in life. It is part of our society and culture to want the newest and coolest. However, both as consumers and as auto lenders we have to do this responsibly for the benefit of overall financial health. The industry is starting to see record highs in lots of areas. Experian’s State of the Automotive Finance Market report shows that 73-84 month terms have become much more common and make up 32% of new vehicle loan share in Q4 2016 up from 29% the previous year. In June 2017, the average new-vehicle loan term hit a record high of 69.3 months. As average transaction prices rise due to interest in SUVs, trucks and sophisticated technology now available in vehicles they stretch their loan term to fit into an affordable payment which is a priority. Does this translate into a formula for success? These longer terms can actually have a negative impact on consumers.
A study by TransUnion finds struggling consumers are making interesting choices on what credit products to pay first. When faced with the choice of which debts to pay and which to miss, consumers in financial distress tend to prioritize unsecured personal loans ahead of other credit products such as auto loans, mortgages and credit cards. This recent study incorporates unsecured personal loans for the first time since TransUnion began analyzing the payment hierarchy dynamic in 2010. Recent TransUnion data shows that average term lengths are much shorter for unsecured personal loans. For loans originated in Q4 2016, unsecured personal loans had an average term of 28 months. In this same timeframe, the length of auto loans averaged 60 months and mortgages averaged 230 months.
Leaders in the automotive industry are starting to see higher loss trends and are socking away money to cover this. Wells Fargo had $890 million in allowance for credit losses in consumer auto loans as of the first quarter, which was up 51% from a year earlier. Ford Credit had reserves of $584 million, up 26% from a year earlier. Ally Financial also added to its allowance, $941 million, an 11% increase from a year earlier. Some lenders have also tightened their underwriting policies, especially in subprime. These are all sound practices from a risk perspective, but is there a way that we can still serve all areas of the credit spectrum?
For organizations seeking actionable insights to manage risks and improve results, LexisNexis Risk Solutions is your trusted data analytics provider. As opposed to just looking at a deal structure and trying to “fit” someone into a payment let us help transform your risk decision making. We can help lenders refine their strategies by focusing on further segmentation as a way to control for excessive risk on longer term loans.
How can LexisNexis© Risk Solutions help?
RiskView™ is a consumer report product provided by LexisNexis© Risk Solutions Bureau LLC and is used as a factor in establishing a consumer’s credit risk, whether that be for buying a car, applying for a credit card, initiating utility service setup, or other lending activity. The LexisNexis Risk Solutions’ methodology produces a three-digit score (ranging from 501-900) indicating the level of the applicant’s credit risk. Scoring can be done machine-to-machine in real time, interactive over a web-based application or in batch runs and can be completed in milliseconds. The creditworthiness predicted by alternative data and analytics correlates well with results returned by traditional credit scoring, so that a credit issuer can identify creditworthiness with these scores about as confidently as with traditional credit bureau scores.