Auto Debt Helping To Drive Tipping Point In Transportation Sector

A third of Americans who traded in cars to buy new ones in the first nine months of 2019 had negative equity, compared with 19% a decade ago, according to car-shopping site Edmunds (chart below). Similar trends are evident in Canada. See A $45,000 loan, for a $27,000 ride: More borrowers are going underwater on car loans.

On average, the balance owing was $5,000 above trade-in value and added to the debtor’s next auto loan–the opposite of a downpayment.

From 2009 to 2015, zero-down and then negative equity loans helped drive the purchase of new vehicles where dealer incentives are most rich, rather than used vehicles, which tend to be the smartest value for the buyer. But as people have become more indebted, and transportation on-demand services more widespread, personal use auto sales in North America (shown below) have stagnated over the past five years despite population growth.

(Click on image to enlarge)

Those with negative equity trade-ins, end up with longer loan terms (i.e., seven years) on depreciating assets with higher interest rates and higher monthly payments. This increases repayment risk and reduces the owner’s spending and saving ability for years after that. In nearly all cases, used vehicles are smarter than new, while ride-sharing in one form or another and taking public transit where possible, are smarter still.

To date, lenders have been willing to make underwater loans because they could be ‘securitized’–bundled into bonds–and sold to investors. But we’ve seen this story before in the subprime housing debacle, and investor appetite tends to evaporate once loan defaults mount, and security prices fall. That’s starting to happen now.

Loan defaults have been rising for the last two years. Some 5.2% of the subprime auto-loan balances were at least 60 days past due on a rolling 12-month at the end of the second quarter of 2019, up from 4.8% the year before (Fitch). Another 4.64% of US auto loans and leases in the second quarter were 90 days or more behind (New York Fed data).  As pointed out by Wolf Richter and charted below, this is a similar delinquency rate as the third quarter of 2009, coming out of the Great Recession.

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