Loan delinquencies are up as buyers continue to take out longer loans and roll over increasing amounts of negative equity.
Car debt is pilling up for consumers who opt to take out larger, longer loans to finance vehicles. New and used car prices and interest rates are up from a year ago, raising payments for buyers, some of whom are paying over $1,000 a month. As a result, people are increasingly upside down on their vehicles, owning more than the cars are worth.
To alleviate some pressure from high car payments, people are trading in vehicles and rolling over up to $10,000 of negative equity into a new auto loan. Many dealers happily accommodate these consumers because it allows them to rake in profits on financing and credit products like gap insurance. However, industry experts warn that even without a recession this year, consumers are increasingly at higher risk of defaulting on their loans.
“Because these car loans are generally unaffordable at the outset, that means that every month, borrowers are getting closer to the financial edge,” said Kathleen Engel, a law professor at Suffolk University. Initially, increasing car values offset some of this risk as new car sales prices increased 20% while used vehicles jumped 37% over pre-pandemic levels. But as inventory returns to normal levels, car values are leveling off.
For many Americans, a new car is out of reach, which has helped keep used car demand high. Loans of 84 and even 96 months are becoming increasingly common. Meanwhile, according to Cox Automotive, severely delinquent auto loans hit their highest rate in January, reaching levels not seen since 2006.
As a result, many auto financing companies are tightening standards, a trend many predict will continue. “The more likely scenario is the worsening of economic conditions combined with the prospects of a continued decline in car prices, making it harder for consumers to qualify for the car they want,” said Renaud Laplanche, co-founder and chief executive officer of Upgrade Inc.
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The possibility of worsening economic conditions worries many people in the auto industry. Pete Kesterson, general manager of a Volvo and Kia dealership in Falls Church, Virginia, is increasingly concerned about buyers with long-term financing. “It’s going to come, and it’s going to bite us,” he said. “Now, we’re selling the cars for so much more, and financing for longer, at a much higher interest rate. There are some challenges coming down the pike.”