February 18, 2019
We received some troubling data on auto loans last week, Tom. According to the Federal Reserve Bank of New York, a record 7 million Americans are 90 days or more behind on their car payments. That is 1.3 million more past-due loans than during the previous peak in 2011, in the wake of the Great Recession. At that time, the unemployment rate was more than twice its current level. While some of these loans can be chalked up to record auto sales in recent years, this report also hints at the financial difficulties some Americans face despite the generally positive economic trajectory of the country.
A couple of factors are at the heart of this, Tom. First, the price tag on new cars is going up. According to Kelley Blue Book, the average price of a new car purchase in 2018 was $36,440, up $7,400 from a decade ago. The rise in auto prices has outpaced overall inflation — and far outpaced wage growth — for the past decade. On top of this, consumers are opting for SUVs over sedans, and automakers are offering more new features in new models, all of which push up the sticker price. Together, these factors have driven the share of take-home income Americans pay to drive a new car off the lot up.
In order to afford that new car, consumers are taking longer loan terms. According to Experian, the most common loan term for new vehicles last year was 72 months, and the number of new loans with 85-to 96-month terms is rising. Longer loan terms not only mean you will pay more in interest over the life of the loan; they also put borrowers at much greater risk of owing more on the car than it is worth, and that can be problematic if the vehicle breaks down or becomes unreliable.
Finally, lenders are offering loans to people with low credit scores, contributing to the increase in the number of riskier car loans. More than 20% of the car loan balances belong to subprime borrowers, who are far more likely to be delinquent on car loans.
Two groups are getting hit hard according to the Federal Reserve Bank of New York’s report: borrowers with low credit scores and consumers under 30. In particular, these numbers suggest young people are struggling to pay for their cars if they have other obligations like student loans or credit card debt.
And if your car is at risk, it can be scary. Many experts note that without a car, many people cannot get to work, to school, or to the doctor in a lot of areas of the country. Since borrowers who are three months or more behind on their car payments often have their vehicle repossessed, this can be an especially stressful situation. On top of that, missing car payments will damage your credit, making it more difficult to get an auto loan in the future.
You have heard me say it numerous times: the most important question to ask yourself is “do I need a new car in the first place?” If your current vehicle does the job and doesn’t cost you much in repairs, you may be better off keeping it while you save money.
If you do need a car but you have a lower credit score, pick your lender carefully. Not all subprime lenders are created equal, and some are more consumer-friendly than others. You want to avoid subprime financing companies if possible. Give your local bank or credit union a chance to finance a loan first. They may have options. And if they do give you a loan, you can use it as a bargaining chip with the dealership, who may be willing to beat their terms.
Third, if you have to buy a car, try to buy a new one rather than a used one. While you might think only about the sticker price, interest rates on used cars tend to be significantly higher, and they have already lost much of their value, meaning you could go underwater on that loan quickly.
Most importantly, don’t buy a car you can’t afford. And when I say afford it, that means you can pay it off in under 5 years. As I mentioned, these long loan terms are risky. Because most cars lose between 10 and 15 percent of their value every year, any loan over 5 years puts you at risk of owing more than your car is worth.
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