Vehicle related debt has increased dramatically. In this post I provide vehicle buying tips which address the financial aspects of a vehicle purchase.
This post is a continuation of my “Vehicle Buying Tips – Part 1” post in which I offer tips to save money on your next vehicle purchase.
My neighbor was formerly the second in command at our local GM dealership before he retired. We met over coffee at which time he imparted some of his knowledge about the sales and financing aspects of the automotive industry.
My neighbor entered the car sales business in the early 1970s. At that time, vehicles were purchased with:
- 30% Cash
- 50% Bank Financing
- 5% – 8% Leasing (only to professionals)
- 12% – 15% Private Money (eg. funding from family)
Twenty years ago this breakdown changed to:
- 30% Cash
- 50% Bank Financing
- 20% Leasing
Ten years ago, as well as today, the breakdown is approximately:
- 10% Cash
- 45% Bank Financing
- 50% Leasing
This breakdown was fairly typical of most dealerships in the area. This is borne out in some of the reports I have read.
Over the course of time, a trend toward an increasing number of customers who had a perpetual car payment became evident. As soon as they finished repaying their car loan, they would look to upgrade their vehicle.
In most cases, customers managed to accumulate a few thousand dollars which they could apply toward their vehicle purchase. Rarely, however, did a customer have sufficient funds to cover the full purchase price of the new vehicle.
I was raised with the view that a moderate level of debt is acceptable on the condition as the asset being acquired has a reasonable change of appreciating in value over time. Financing the purchase of a vehicle over terms as long as 84 months definitely does not meet this condition.
Vehicles depreciate almost 11% in value the moment they are driven off the dealer’s lot. By the time the final payment is made, a vehicle is of minimal value.
I was alarmed when my neighbor explained the extent to which customers would shop for a replacement vehicle even though they still owed money on their current vehicle! In many cases, my neighbor’s dealership would counsel their customer to find the funds to extinguish their current obligation before taking on any new debt.
Customers who did not have the wherewithal to do so would find another dealer who was prepared to consolidate the outstanding debt together with a new “new vehicle” loan. Interest rates on such loans were generally at a much higher rate given that the level of risk was greater.
After our conversation I did some more research on the state of the auto financing industry. I learned that toward the end of 2015, auto loans had grown to more than $1.1 trillion.
In February 2016, Fitch Ratings warned that the rate of seriously delinquent subprime car loans it examines rose to the highest level since 1996. That uptick caught the eye of government regulators. The Office of the Comptroller of the Currency, a frontline bank regulator, warned in July 2016 of risks linked to the “unprecedented” growth in auto loans, rising late payments, and shrinking used car values.
The Office of the Comptroller of the Currency pointed to cutthroat competition among banks which led to the relaxing of underwriting standards. An even bigger problem, however, was with auto finance companies which are the source of the vast majority of subprime loans.
Most recently, CNNMoney has reported that car sales had increased for 7 straight years and are now at near record levels even though vehicles are becoming increasingly expensive with each new model year. In fact, car prices are at record levels. This is partly because buyers are shifting from less expensive cars to crossovers, SUVs and trucks, and partly because of demand for the latest safety and tech features, such as automatic braking and internet.
If you are a Canadian resident, you can find the March 2016 Auto Finance: Market Trends report published by the Financial Consumer Agency of Canada here. This report focuses on the auto loans offered by federally regulated lenders and the risks posed to consumers by extended-term loans.
In November 2016, the Federal Reserve Bank of New York published its Quarterly Report on Household Debt and Credit. Billions of dollars in auto loans are extended to borrowers with sub-standard credit ratings.
Positive Automobile Sales Trend Fueled by Easier Forms of Financing
We know cars are becoming increasingly expensive and most people are unable afford to buy a vehicle outright. In order to achieve a positive sales trend, automakers offer cash-back deals and easier credit for buyers in the form of more liberal leases and longer-term car loans.
With all this cheap money being thrown around, you think there might be a few delinquent loans on lenders’ books? Well, try this on for size.
With the continued dramatic increase in car loans, the latest Quarterly Report on Household Debt and Credit from the New York Fed’s Center for Microeconomic Data indicates roughly six million auto borrowers with shoddy credit scores are at least 90 days late on making their loan payments. The percentage of delinquent subprime auto loans had reached its highest level since 2010.
While the above noted links take you to US related statistics, the problem is not unique to the US. The Financial Consumer Agency of Canada issued a report in early March 2016 which revealed that consumers are often buying more car than they can afford, paying much more interest. In some cases, as I noted earlier in this post, consumers buy new cars before their current vehicle loan is fully repaid. In addition, tantalizingly low interest rates, sweeteners like stretched out loan timelines, and increasingly confident consumers who worship their wheels, has resulted in car debt growing at a phenomenal pace.
If you are burdened with a perpetual vehicle payment check out my Reduce Stress and End the More Month Than Money Dilemma post.
- Find ways to eliminate unnecessary expenses or find additional sources of income so you can set aside enough money to make a significant deposit on the purchase of your next vehicle.
- Consider purchasing a good condition low mileage pre-owned vehicle.
- Say “no” to add-on features the dealership will try to foist upon you (read Vehicle Buying Tips – Part 1).
Be creative. I am sure you can think of ways to lessen or eliminate the burden of recurring car loan payments.