Auto Loans Get Even Dicier

Record numbers of shoppers are trading in cars while still underwater on their loans

By Aaron Back

A General Motors used-car dealership in Michigan in 2010. Photo: Bill Pugliano/Getty Images        

After a yearslong boom in lending, signs of trouble are popping up in auto loans.

In the past few weeks, some auto lenders have warned that default rates are creeping up. Used-car prices are also falling faster than many anticipated, leading to lower recovery amounts when borrowers do default.

The latest stress signal comes from auto research firm, which said in a recent report that record numbers of shoppers are trading in old cars for new ones when they still have substantial amounts due on their existing car loans.

In the first three quarters of 2016, the number of these new-car purchases with negative equity on previous loans reached a record 32% of all trade-ins, according to Edmunds data. That is up from 30% in the same period a year earlier and just 22% five years ago. The average amount of negative equity also reached a record, at $4,832.

That is significant when one considers that the average selling price for a new car is around $33,000, says Edmunds analyst Ivan Drury.

As a result, many borrowers are rolling over their balances into new loans, pushing loan-to-value ratios above 100%. They have to pay that back over time, either through higher monthly payments or a longer payback period. Already, payback periods have risen to an average of 69 months, from 63 months five years ago, according to Edmunds.

For auto lenders, this all means the probability of future defaults is rising. And if lenders respond by finally tightening credit standards, car sales will suffer. Ultimately, someone has to foot the bill for frothy auto lending.

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