If you know the story of Chicken Little, you know how detrimental it can be to jump to conclusions and spread misinformation like wildfire. And that’s exactly what we’re seeing when it comes to the health of the auto finance industry.
It’s certainly understandable since the housing market crash that started back in 2006 isn’t a too distant memory. It was a disaster and we’re yet to fully recover from it. But when you look at the big picture, the sky is not falling on the auto finance industry. There is no bubble. Everyone just take a deep breath.
Here’s the gist of things. Like the economy, the new and used car market is on a major upswing with a record-breaking 17.5 million cars and (light) trucks sold in 2015. Since buyers rarely pay in full, this has created $1.027 trillion in outstanding balances according to Experian, up from $932 billion a year ago.
Part of this jump in sales can be attributed to credit score requirements relaxing to pre-recession levels. That means subprime buyers are finally able to buy the cars they desperately need. However, loan terms are longer and interest rates are higher than they were just a few short years ago. That means if buyers want to trade in a car for a newer vehicle, they might find that they owe more than it’s worth.
So, is all of this change something to worry about? Of course not.
Let’s discuss three areas that need to be examined: longer loan terms, subprime versus deep subprime buyers and equity and interest rates. We’ll dive into the first two topics in this blog.
About Those Longer Loan Terms
First of all, while extended car loans are being used more often these days, no buyer is strapped to a 30-year financing agreement like they are when buying a house.
According to Experian, the average loan term is now 68 months, with the average sub prime loan averaging 43 months. And according to the Federal Highway Administration, Americans average around 13,476 miles driven each year. That means a buyer will put about 76,000 miles on the car while paying it off. When there are numerous cars from nearly every automaker that will go for at least 200,000 miles, the mileage and terms absolutely make sense.
What we’re seeing is dealers and lenders simply adapting their payment terms to give buyers the cars they need to get to and from work, as well as shuttle their children to school and soccer practice. A car is a true essential for many households.
Subprime vs. Deep Subprime Buyers
Unlike the finance companies that recklessly gave loans to people who should never have qualified for a 30-year mortgage, dealers and lenders are not throwing caution to the wind, much less preying on deep subprime buyers.
Experian reports show that deep subprime only makes up 3.5% of loans and leases, while subprime is at 17.9%. If you look at totals – subprime and deep subprime loans and leases for both new and used vehicles, this segment of buyers dropped from 23.3% in Q2 of 2015 to 22.8% in Q2 of 2016.
Many of these subprime buyers are also far more creditworthy than their scores might show. Millions of people were affected by the recent recession. Jobs were lost, homes were lost, retirement funds were obliterated. If you came out with your credit score unscathed, you were lucky. Many subprime buyers are also on the upswing and being able to buy a car ultimately helps them improve their credit score.
Want to know about equity and interest rates and what all of this means? Catch part two of our auto finance industry update. Coming soon!