Interesting Wall Street Journal article talking about how loan terms continue to get longer and longer...
New risks are lurking in auto loans.
As loan growth slows, banks and other lenders have been tinkering with loan terms in an effort to gain more consumers. They are originating a greater share of loans with repayment periods of more than five years and, in some cases, extending loans to consumers who are stretching further to afford their purchases. Banks such as TD Bank, Santander Consumer USA Holdings Inc. and BB&T Corp. , meanwhile, have said they are increasing their loans to riskier applicants.
Their moves come at an unsettled time for auto lending. Sales growth has been choppy and missed payments are up from a year ago. Also, used-car prices are under pressure, raising the risk of higher losses for lenders when vehicles are repossessed. Faced with these headwinds, many lenders shunned applicants with low credit scores and have been looking for ways to make up the lost volume.
The latest underwriting efforts show that lenders, faced with conflicting signals about the health of the U.S. consumer, are engaged in a delicate balancing act to boost lending and profit without taking on overly risky customers. Though unemployment has reached an 18-year low and wages are creeping higher, some households are sliding deeper into debt and falling behind on their credit cards and other debt payments.
"[If] you only took on the financing for the top echelon of the super prime... [it’s] very, very hard to make money in and of itself,” TD Bank Chief Executive Greg Braca said at an industry conference this year.
Many auto lenders, including banks, nonbanks and the finance arms of car manufacturers, have been offering more loans with longer terms. Generally, these terms allow borrowers to make lower monthly payments, but usually at a higher interest rate. That, combined with the longer payment period, means that borrowers can end up paying thousands more for their cars than if they opted for a shorter loan.
In the first quarter, the average loan term for a new car exceeded 69 months, the second consecutive quarter it had ever been above that level, according to credit-reporting firm Experian. Also in the first quarter, new car loans originated with repayment periods of between 73 and 84 months represented more than a third of total new car loans, up from 7% of loans in late 2009.
Lenders say borrowers need flexible terms because new vehicles are getting more expensive. Despite the longer repayment periods, average monthly loan payments continue to rise, hitting a record $523 for borrowers who bought new cars in the first quarter, according to Experian.
Zac Craft wanted a three-year loan when he bought his 2012 Chevy Cruze this year but opted for a five-year loan despite its slightly higher interest rate. Mr. Craft plans to pay off the loan in three years to cut down on interest but wanted the option to make lower monthly payments when money is tight.
“There’s some security in that,” said Mr. Craft, who lives in Hawaii.
Lenders pushed into subprime auto lending after the recession, which helped boost vehicle sales. Subprime auto lending peaked at $114.4 billion in 2015, according to Equifax, accounting for 19% of auto loans and leases that year. Higher loan losses followed, and lenders subsequently tightened underwriting standards. That resulted in a drop in new car sales and loan originations last year.
While subprime lending is declining, some banks are turning to consumers whose credit scores are neither high nor low. TD Bank, Santander Consumer USA and BB&T say they have been extending more loans to borrowers they define as “nonprime” or “near prime.” Santander and BB&T also originate subprime auto loans.
Skeptics say the term nonprime is another way to label less-than-ideal borrowers without alarming investors. Nonprime and subprime customers can generate better returns because they tend to pay higher interest rates.
“When you can kind of operate in the belly of credit and generate 7-plus-percent yields on new originations, that’s pretty attractive business,” Ally Financial Inc. Chief Executive Jeffrey Brown said at an industry conference this month. Ally, one of the largest U.S. auto lenders, does business with borrowers across the credit spectrum, including subprime.
Lenders say they typically make the longest loans to prime customers who can afford them and understand the risks. A report last month by Moody’s Investors Service, however, found that borrowers who sign up for loans that last six years or longer have lower credit scores and owe a larger share of the vehicle’s price than consumers with shorter loans. The loan payments also account for a larger share of their income, said Moody’s, which reviewed loans securitized since 2017 and that were mostly comprised of prime borrowers.
At Ally, for example, borrowers with loans stretching six years or longer owed on average around 100% of the car’s purchase price when those loans were originated, according to Moody’s. Borrowers with a shorter repayment period owed 83%. Credit scores for borrowers with the longer loans averaged roughly 725, compared with about 760 for borrowers with shorter-term loans.
Similar rifts exist with loans extended by auto makers’ in-house financing arms, including Ford Motor Credit Co. and American Honda Finance Corp.
A Ford Credit spokeswoman said the company’s lending standards haven’t changed and that longer-term loans are “a relatively small part of the business.” Honda Finance has kept its maximum repayment period at 72 months, a spokesman said.
Loans with longer repayment periods are more prone to default, according to Moody’s. Loans of five years or longer extended to borrowers in 2015 with high credit scores had a cumulative net loss rate of 1.29% as of spring 2017. For shorter-term loans, the loss rate was 0.28%.