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article imageOp-Ed: New auto lending trends may signal long-term trouble

By Lori Weaver     Oct 29, 2013 in Business
After the housing finance bubble burst, mortgage lending went through tremendous change in an effort to keep consumers from purchasing more house than they could afford. Now, some of those same concerns are surfacing in the auto-lending sector.
Buying a new car today can have consumers trying to overcome a host of challenges, but sometimes the solution is as risky as the problem.
The Great Recession left countless consumers with lower credit ratings, higher debt and depleted savings accounts, as many had done whatever they could to stay afloat in the face of challenges like job loss, foreclosure and unending bills.
Worries over the bubble
Many of these same consumers held onto their old vehicles during the economic downturn, typically not by choice but out of necessity. But that mindset appears to have changed. According to the New York Times, strong end-of-summer auto sales helped put the seasonally adjusted annual industry sales rate at a post-recession record-breaking 16.09 million, a significant increase from 14.49 million a year ago.
These strong sales suggest that at least a portion of the large number of potential buyers making their way to showroom floors are probably bringing credit challenges with them.
Although a reliable vehicle can be the ticket to stable income and financial recovery, experts are concerned that some of the lending practices aimed at helping more consumers get into new vehicles, despite financial challenges, could result in another financial meltdown or at least, not be in the best interest of consumers over the long run.
While automakers may be increasing production to meet demand, interest rates could rise, causing further financial challenges for those with compromised credit. Difficulty in financing could then cause a drop in demand, forcing automakers to take action, like offering discounts, to increase sales. If these discounts and other measures go on for too long, they cut into profits and the industry risks a crisis not unlike that seen in 2008, when the recession began.
But auto lender Prescott Financial points out that even if interest rates go down, easier auto loans are not necessarily a good thing for the public, either. While drivers may find the lower monthly payments they seek, they also risk ending up behind the wheel of a vehicle they can't afford. That means, like troubled home owners before them, they may end up owing much more than their vehicles are worth.
Extending loan terms
One of the trends that has emerged since the start of the economic recovery has been the extension of loan terms. Only a few short years ago, loans over 5 years in duration were considered unusually long. Today, these longer-term loans make up a whopping 41.7 percent of all new car loans in the U.S., according to data compiled by Experian Automotive.
At the same time, the category of longest-term loans— those stretching as long as 73 to 84 months—has increased over 25 percent in the past year alone and today make up 19.5 percent of all new-car lending. Fewer new loans have been made that fall into shorter loan-term categories as consumers continue to embrace the longer-term lending options.
This trend is in contrast to the situation that took place during the Great Recession, when lender approval was much more difficult to come by, even with shorter-term loans and borrowers who had an average or above credit rating.
Some auto dealers claim even those with high credit score are opting for longer-term loans, according to the USA Today, but the terms are likely most attractive to consumers who would have a difficult time financing the higher monthly payments of a shorter-term loan.
Lacking equity and paying interest
Still, repaying an auto loan over a longer period of time has serious drawbacks. Consumers have historically measured potential new car affordability based on the monthly payment alone.
While longer-term loans are meeting that demand, they may also cause a buyer to run into problems when he or she goes to trade in the car and realizes the remaining amount of the loan is more than the vehicle is worth. Even if kept for the duration of the loan, the longer-term means consumers end up paying much more interest over the life of the car, greatly escalating the overall cost of a new vehicle.
Experts generally agree that even consumers with credit challenges should compare auto loan quotes and attempt to keep the loan term as short as possible, preferably no longer than 48 months. The bigger monthly payments are a better choice for most consumers, and for the economy, than the financial headache long-term auto loans could cause.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of DigitalJournal.com
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