After a decade of increasing auto loan market activity, lenders are pulling back as Americans struggle with affording their new cars. As a result, Americans are seeking longer terms on their loans and moving away from the traditional five-year contract according to the Consumer Financial Protection Bureau (CFPB).
Between 2009 and 2017, six-year, seven-year, and longer-term loans grew in popularity as the volume of five-year auto loans fell. If a borrower is struggling to meet monthly payments, one of the solutions is to extend the repayment term, spreading the lump sum over more installments. Monthly payments go down, but the overall cost of borrowing increases over the life of the loan.
Additionally, the CFPB published a another report highlighting several changes in the auto loan market in America. Auto lending volume to subprime borrowers has increased over the last few years. Since these borrowers are inherently at a greater risk of default, many consumers with poor credit and low income can extend the repayment term, reducing monthly obligations. It also helps explain the trend from the more recent report by the CFPB.
It’s a simple trick, but it comes with repercussions for both the lender and borrower.
When a loan repayment schedule is spread over a longer time period, car buyers end up paying more interest over time. While reducing monthly payments can be beneficial, a longer term increases the overall cost of buying the car, and it often hurts Americans ability to save for a rainy day or invest their income in capital markets. The CFPB views this as a risk factor for low-prime consumers’ long term finances.
However, on the other hand, lenders can make more money off of these auto loans, albeit the return takes longer to come into fruition. On top of this, since sub-prime borrowers could theoretically have a better chance at finishing repayment, it could be assumed that auto lenders are reducing their risk by lending a long-term loan to a sub-prime consumer.
This would sound great for lenders if the CFPB didn’t debunk this theory. The same report found that long-term auto loans defaulted at more than twice rate of shorter term loans (8+ percent compared to 4 percent, respectively). With that being said, it’s reasonable to conclude that auto lending in general is getting riskier for both lenders and consumers.
“The move to longer-term auto loans is opening up more risk for consumers,” according to CFPB Director Richard Cordray. In a recent press release, he cautioned Americans that longer terms are more expensive in the end and many Americans are saddled with making payments long after their vehicle is off the road.
The CFPB provided several other interesting statistics aside from Americans with lower credit scores and lower income being the biggest consumers of six or seven-plus year loans. The typical auto loan amount increased over time, and Americans’ appetites for new cars remained strong despite car costs outpacing inflation. For instance, the average car loan opening balance increased from $18,179 to $21,088 from 2009.
Car loans are the third-largest category of consumer debt in America. Only mortgage debt and student loan debt are more prominent in the debt category. In the US, the auto loan market applies to over 100 million vehicles with an outstanding debt balance that is over $1 trillion.
For most Americans, it doesn’t make sense to extend your car loan beyond five years. Vehicles are a notorious depreciating asset, and borrowers often find themselves paying for a vehicle they no longer drive. One of the best tactics to avoid this situation is borrowing within your means and paying your loan back on the shortest timetable possible. It’s great to have a low monthly payment, but it’s important to keep long term financial health in mind when you sign on the dotted line at the dealership.