The media has trumpeted loud and often the real estate market is in trouble. Home values have dropped nationwide leaving 23 percent of the homes underwater. (1)
Lesser mentioned is the number of vehicles underwater or upside-down to borrow a term used in the auto industry. Being upside down simply means you owe more on the vehicle than it’s worth.
The auto industry does not have available statistics on the extent of upside-down auto loans but the numbers may be greater than the number of homes that are underwater.
How did this happen? What impact does the prevalence of upside-down auto loans have on the number of vehicles sold today?
Twenty or so years ago a car buyer needed at least 10 percent of the purchase price of the auto as a down payment before the dealer would put the customer on the street. If your credit was less than perfect, you were looking at a cash down payment of 20 to 30% of the purchase price.
In the 1990’s credit loosened up as more money was made available by the banks, finance companies and credit unions for financing vehicles. The dealerships had more financing options to offer the buyers, creating an environment where a broader segment of society was able to finance a vehicle.
After the World Trade Center Bombings, the prior guidelines governing auto financing began to disappear and an era resembling the wild west of auto lending began to take its place. In the 1980’s auto financing was limited to 36 or 48 months max for a new vehicle. Five years ago 72 month financing terms was the norm to get the car buyer in the vehicle of their dreams at the lowest possible payment. Terms of 84 months and in rare circumstances 96 months stretched financing terms to the extreme all in the name of rolling another unit off the lot.
Combine a loan term of 72 months with first year depreciation as much as 30 to 40 percent in some models, the borrower may not see positive equity in the vehicle until 60 payments have been made.
Zero down, Zero percent APR was the incentive U.S. auto manufactures offered on some models to get buyers back in the dealership after 9-11. The zero down enticement which at one time had been the exception had turned into the expectation for many buyers, putting pressure on the dealers and lenders alike, pushing the average loan to value to record heights. The car buyer was calling the shots in many cases.
The paradigm in the auto industry had shifted but the habits of many buyers had not. A new vehicle every two or three years is a fact of life for many drivers. What had changed was zero down combined with extended financing terms and auto lenders adjusting loan policy to accomodate the escalating negative equity in an increasing number of trade ins. As the economy tanked and unemployment rose, the increasing number of repossessions carried with them in a greater severity of loss.
Reality dealt a harsh blow to the auto industry in the fall of 2008 when vehicle values plummeted at the auctions just as the available credit for financing dried up. The car buyers who had been accustomed to trading in their vehicle every two or three years was now sitting on the sideline as the auto lenders were now unwilling to absorb the negative equity some drivers had been rolling from one purchase to the next for the better part of a decade.
What impact does this have on auto sales? The car buyers who had purchased their last two or three vehicle with little or no down payment are finding that they will have to postpone their next vehicle purchase until the loan on their current vehicle is paid off.
(1) credit.com article by John Conroy 8/13/09
Jeff Hubbell has been in the auto finance industry for the last 13 years.
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