Mortgage lenders are spinning their wheels as more and more borrowers with weak credit are unable to make payments now that their adjustable rates have reset. This has made it difficult for the lenders to unload new mortgages on investors, bringing their businesses to a standstill. In the case of auto lenders, rate resets aren't the problem -- the rates on most auto loans are fixed. But the terms of these loans are getting longer as consumers stretch to buy more car than they can afford. Longer terms help to lower monthly payments, offsetting the impact of rising interest rates and allowing them to put less money down.
"Most consumers still come into dealerships and tell the salespeople that they want to pay a certain amount of money per month for their car," says Jesse Toprak, executive director of industry analysis for Edmunds.com. "That is probably the single worst way to shop."
According to Edmunds.com, the average financing term for loans on new cars was over five years, or 63.8 months, at the end of August. That's up from 59.8 months five years earlier.
Some loans are even longer -- as long as eight years. According to JD Power & Associates, nearly 39% of loans made year to date had original terms of between 72 and 83 months, up from 31% in 2004. And 3.9% of loans made so far this year had original terms of at least 84 months, up from 2.4% two years earlier.
To be sure, those terms are much shorter than the typical mortgage -- on average, homeowners sell or refinance, paying off their original loans every 10 years or so. But auto loans of five, six or even eight years are risky for lenders because, unlike homes, cars and trucks depreciate rapidly. Most vehicles lose about a third of their value once they are driven off the lot. So the longer borrowers stretch out payments, the more time loans spend underwater -- a term meaning the balance is bigger than the value of the vehicle securing it.
Longer auto loans are also a bad deal for borrowers, who end up paying more interest over the life of the loan. For example, on a four-year, $30,000 loan with an interest rate of 7%, you would have a monthly payment of $718.38 and pay a total of $34,482 over the life of the loan. Extending the terms of that same loan to six years would lower the monthly payments to $511.47, but you would pay a total of $36,825.
And the longer the loan, the more likely owners will still be making payments when they want or need to buy a new car, a concept known as "negative equity." "At least one in four customers who trade in a car have negative equity," says Toprak.
How much negative equity? The average is at least $3,000.
(With so many people facing negative equity, U.S. carmakers have resorted to offering cash rebates of up to $5,000 to steer potential buyers to new models.)
Why are lenders willing to make such risky loans?
One reason is that auto sales are down, thanks in part to the fact that many homeowners are having trouble making mortgage payments now that the interest rates are resetting. That makes lenders more flexible in lending to people with less than perfect credit. Toprak says this is particularly true of lenders tied to automakers, like GM's (GM) General Motors Acceptance Corp. and Ford's (F) Ford Motor Credit.
"For most customers, if they can't get a car loan, they can't buy a car," Toprak says. "The 72-month loan is becoming more of a norm than an anomaly."
Lenders aren't just extending the terms of auto loans. Data from Standard & Poor's on pools of auto loans that are bundled into securities indicates average credit scores are slipping and investors are putting less money down.
And unlike the mortgage industry, where it has become difficult for anyone with less-than-perfect credit to get a loan, some auto lenders are actually making a bigger push to lend to subprime borrowers.
"It's not any more difficult to get an auto loan with subprime credit than it was three years ago," Toprak says. "But the rates are higher, and [buyers] may have to put more money down, and the loan-to-value ratios are more carefully judged."
Lenders are already starting to pay the price in terms of higher delinquencies, although bad loans are just coming off historic lows.
S&P says that, among securitized auto loans to prime borrowers, 30-day delinquencies increased 37% for 2006 issuances compared with 2005, and are up by 24% for 2005 securitizations vs. 2004. The figures are as of the end of July.
In the subprime market, delinquencies climbed by 7% for 2006 vs. 2005, and 22% for 2005 loans compared with 2004.
Cumulative losses on prime 2006 loans are trending by 20% higher than 2005.
Cumulative losses on subprime pools are up by 14%.
However, Amy S. Martin, a director in S&P's structure finance division, says retail auto loan securitizations "are generally performing within expectations." The ratings firm does not have any issues on watch for a possible downgrade.
GMAC says it has experienced little fallout from the recent turmoil in the credit markets. "We've remained consistent in our credit scoring criteria and the way we do our underwriting," says spokesman Mike Stoller. "Our delinquencies are still in the band of historic lows."
"Other businesses, like banks, are the ones that are really pushing longer-term loans," says Ford Motor Credit spokeswoman Brenda Hynes. "Any sort of loans that we do, we're basically following that market to be competitive. As far as the effect of the current credit crunch, we aren't seeing any change, and our purchase policy hasn't changed, and thus the length of our contracts haven't changed either."
S&P says that mortgage problems aren't as pressing a concern for subprime auto lenders as they might be for other lenders because fewer people taking out auto loans own homes. In subprime auto loan pools, the percentage of homeowners can vary from 0% up to 50%, lender by lender.
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