The car market may be experiencing a bubble. Nearly 25% of all auto loans are currently being awarded to borrowers with subprime credit, causing many investors to worry that an onslaught of defaults is just around the corner. If this story may sound familiar, it’s basically the car version of what happened with mortgages during the financial crisis of 2007.
Overall auto lending has been occurring with greater and greater frequency, though this has gone largely unnoticed by the press. The past few years have brought record highs in terms of the average price paid for a car, the average amount of a loan, and even the average monthly loan payment. To manage that debt, lenders have stretched the average duration of a loan to a whopping 68 months, which is the longest payment period on record.
“A longer loan lowers the monthly payment and makes that vehicle more affordable,” explains Melinda Zabritski of credit-analysis firm Experian. “The risks are, you’ll pay more interest and your total cost will be higher.”
American consumers as a whole hold more than $1 trillion in automotive debt, which is also an all-time record. While automotive debt isn’t inherently risky, financial trends can spell trouble for auto manufacturers due to the negative equity that potential buyers in the future will hold over the vehicles they own today. If it becomes a common trend that drivers owe more than the vehicle is worth more longer periods than ever before, this will likely depress sales during the time that many buyers cannot purchase a new car until they come up with the thousands of dollars necessary to paying off what they still owe the old one.
So despite the fact that the automotive industry has been chugging forward at full speed with sales running at a strong annualized pace of around 17.5 million models and sales of trucks and large SUVs have been soaring in light of the cheaper gas prices, things can be expected to change in the next few years. New crossovers like the Honda CR-V, Hyundai Tucson and Mazda CX-5 have all cut into the sales of economy cars, bringing higher profit margins than is generally expected. Right now, the average buyer spends around $33,845 for a brand new car, which is up 3.5% from last year. On top of that, the average loan has risen to an astounding $30,031 with $503 monthly payments.
Car buyers and loaners alike are focused on the monthly payments and keeping them manageable. Loans may run for as many as eight years, even longer for unusual fringe vehicles. The easier lending and more flexible terms made possible by automakers helped the auto industry to dig itself out of the hole it fell into during the 2008 downturn, but they may be setting the stage for the next downturn.
“With more buyers in longer loans, you won’t get this rapid turn at 36 or 48 months,” explains John Mendel, executive vice president of American Honda. “There’s a concern that it will cost more to trade in the car, so they’ll probably keep it.”
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