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Black Book Identifies Drivers of Stretching Loan Terms

May 20, 2015

LAWRENCEVILLE, Ga. — Despite household incomes remaining relatively flat and transaction prices reaching new highs, the industry is on pace to realize its sixth straight year of year-over-year sales increases —the first time in more than 50 years. The main driver: stretching loan terms.

In a white paper released this week, Black Book identified several reasons consumers are agreeing to longer terms. It also explained why more and more finance sources are playing in that 72- to 84-month loan term range, which, according to Experian Automotive, represented roughly 26% of new-vehicle registrations in the fourth quarter 2014 — a 20% increase from the year prior.

“Longer loan terms are necessary today to keep monthly payments beneath $400 — a sweet spot for many consumer auto budgets,” the report read, in part. “In order to accomplish this, lenders must extend out the terms because household income growth had not kept pace with transaction price increases over the last several years.”

The report cited U.S. Census Bureau data from 2007 to 2012, which showed that household incomes rose only 1.6% from an average of $48,729 to $49,486. During the same period, however, the average price of a two- to six-year-old vehicle rose 24.9% from an average of $11,160 to $13,949, according to Black Book vehicle valuation data.

And according to J.D. Power and Associates, the average transaction price in March stood at $30,530, the highest recorded price for that month.

What’s also driving consumers to accept longer terms is their appetite for safety and luxury features generally offered on more expensive trim level. The cost of ownership, which has increased, is another reason terms are stretching, the white paper noted.

“This is forcing the consumer to extend terms in order to maintain family budgets,” the white paper stated. “Consumers generally prefer payments under $400 a month, and lenders prefer to see obligations less than 20% of the monthly household budget.”

And there are several reasons lenders are becoming less adverse to the risk posed by longer loan terms. For instance, U.S. employers have added 200,000 more jobs in each of the past 12 months as of March, a feat that hasn’t been achieved since 1997.

The U.S. economy is also expected to grow 3% this year, which hasn’t occurred in more than 10 years.

“Lender portfolios benefit from consumers’ willingness to pay more for vehicles, and the continuously improving economy has kept credit scores and delinquency rates healthy,” the report noted, adding that several new lenders have entered the space for loans of 72 months or longer.

There’s Ally, which recently announced an 84-month loan package to well-qualified customers this past February. Chrysler also announced an expansion of its appetite for longer term loans. The company’s percentage of loans with terms of 73 to 75 months increased from 19.9% to 20.1% during the first quarter of this year, a 9.8% increase from a year ago.

“Profitability on loans underwritten to traditional standard terms lack the desired loan margin at current loan rates. Increasing risk is the common method to profitable growth in a market exploding with competitors,” the report reasoned, noting that even Ally CEO Jeffrey Brown has said the finance source “underachieved” the past two or three years by not taking on enough credit risk.

“Many lenders seek the opportunity to enhance their portfolio margins through the portfolio management via increasing loan terms vs. relaxing credit criteria.”

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