Phil LeBeau, from CNBC, recently published an article highlighting trends in car buying. One of the statistics mentioned in the article stood out to us. That is, nearly 25% of new auto loans have payment terms between six and seven years. Currently, auto loan terms have been extended to record highs due to increased vehicle prices, low interest rates, and car buyers holding onto their vehicle for longer periods of time.
Many questions come to mind regarding the impact on the consumer and on the auto industry, as well as the economy. Surely, taking a deeper look into the loan portfolio’s credit details would provide some insight into the future implications of this trend.
Simply put, we would recommend buying a more affordable vehicle and would not advise taking an extended loan on a depreciating asset.
The buyer that tends to trade-in their vehicle early would be most at risk with these loans. Because of the very large depreciation hit the first year of ownership, and the front loaded nature of the interest portion of monthly payments, a significant portion of auto loans are “under water” for a number of years. According to Edmunds.com data, (http://www.edmunds.com/car-buying/being-upside-down.html), in the first quarter of 2014, nearly 28% of car sales involving a trade-in had negative equity. The average amount owed was $4,223. In this instance, the amount would be wrapped into these longer term loans and the problems will continue to build.
At the same time, these loans can be reasonable for the car buyer who tends to maintain ownership of the vehicle for the life of the loan, or longer, and needs the minimal monthly payment. The low interest rates have helped the consumer demand and growth in the US auto market. Looking down the road, the auto market will continue to face challenges, but increasing opportunities will be created.
Today, the average age of US vehicles on the road is 11.4 years. The increased prices and the rise in longer duration loans would make one believe that the age of ownership will continue to increase. It is questionable how long and sustainable the consumer will be able to keep up with the new auto market. Regulatory challenges, as well as the consumer demand for connectivity and content, will create pricing pressure and potentially lower future profits. This has, and will continue to create opportunities for manufacturers to create models that appeal to the consumer, at a lower price point, according to a recent McKinsey and Company report.
These issues do not present immediate threats to the health of the auto industry or our tepid economic recovery. Yet, it will be interesting to watch the trend in consumer behavior and the way the auto industry adapts to new opportunities.
All comments and suggestions are welcomed.
Tony Basalla