Negative equity, long loan terms reach worrying levels
Negative capital levels hit record highs as lengthening loan terms, rising transaction prices and falling used vehicle values combine to wreak havoc on consumers and industry .
In the first quarter of 2017, the percentage of trades on new vehicle sales with negative equity reached a record 32.8%. The average amount of negative equity, at $ 5,195, was also high, according to data from Edmunds.
Average negative equity amounts have exceeded an average of $ 4,000 since the third quarter of 2013. The higher levels came as the economy recovered from the recession, according to Ivan Drury, senior director of analytical development of Edmunds.
From 2009 to 2011, negative equity fell “just because people couldn’t get a loan for a new car,” Drury said. As vehicle financing dried up during the recession, many consumers were forced to hold onto their vehicles, so they paid off more of their balance. “When they finally got to the dealership,” he said, “they didn’t owe that much.”
Now that most consumers have recovered from the recession, they are more likely to trade in their vehicle sooner, often before their loan term expires. This practice contributes to higher amounts of negative equity.
Consumers are extending the terms of their loans as they strive for the lowest possible monthly payment. The average term of new vehicle loans in the first quarter was 69 months, up five months from the first quarter of 2011, according to data from Edmunds.
Loans with terms of 73 to 84 months also increased, according to Experian, accounting for 32.1% of the share of new vehicle loans in the fourth quarter of 2016, up from 29% a year earlier. As for used vehicles, loans with a duration of 73 to 84 months accounted for 18% of the share, against 16% a year earlier.
Additionally, there has been an upward movement in the 73-84 month loan segment, according to Melinda Zabritski, senior director of auto finance at Experian. “Years ago, when you saw lenders start to fall into this category, they were at the bottom of the scale,” between 73 and 75 months, she said. “Now we are seeing a shift within this category where more loans are actually being taken out at 84.”
Despite loans that can stretch for much of a decade, many consumers continue to trade in their vehicles every few years, resulting in higher negative equity amounts.
“Think about how principal and interest accumulates on a 60 month loan or a 66 or 72 month loan,” said Cheryl Miller, vice president of lender solutions at Dealertrack. “The equity that the consumer builds from a capital perspective is (less) than that of a shorter term loan.”
If consumers are used to, say, a five-year trading cycle but extend their term to six years and beyond to keep monthly payments low, they “find themselves caught in this vicious cycle,” Drury said.
Rising transaction prices
Economic conditions, including low gasoline prices, low unemployment rates and pent-up demand, have prompted consumers to purchase vehicles in recent years. In 2016, light vehicle sales in the United States hit a record 17.5 million. Strong demand, especially for the latest vehicle technologies and for more expensive journeys such as trucks and SUVs, has pushed up transaction prices. The average transaction price for a new vehicle reached $ 34,802 in the first quarter, up 3.8% from the previous year period, according to Edmunds. Compared to the first quarter of 2012, the average transaction price for new vehicles jumped 15.6%.
The upward trend in transaction prices is contributing to negative equity, Drury said.
“A lot of people are switching to more expensive vehicles. This is part of the problem,” he said. “Every year we see (the average transaction price of new vehicles) go up. Funding stretches longer.”
The technology “is definitely a game changer,” he added. “Like anything, if you can afford it, you will.”
The values used plunge
The fall in the value of used vehicles also affects clients’ equity positions during the takeover. Pre-owned stocks have taken a hit as non-rental vehicles and trade-in saturate the market. The Black Book Retention Index showed 27 months of almost continuous declines in used vehicle prices from January 2015 to March 2017.
Lou Loquasto, auto finance leader at Equifax, pointed out that declining value of used cars, rising prices for new vehicle deals and larger loans were the main drivers of negative equity. These factors influence negative equity more than aggressive lending, he said.
Overall, these factors, along with long loan terms misaligned with early recovery cycles, have propelled the industry towards the record amount of average negative equity.
“I have rising car prices. I have declining trade-in value. My consumer continues to make some sort of down payment, but wants to trade at the same cycle, resulting in a slight increase in negative equity, ”Dealertrack told Miller.
Still, the negative equity seems manageable, she said. “It’s not as if the greater percentage of the population that trades in cars (is) in a negative equity position.”
But at over $ 5,000 on average, Drury said, it’s worth watching.
“Why so many motorists are underwater” originally appeared in Automotive News on 6/12/17
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