Negative-equity levels are at record highs as lengthening loan terms, rising transaction prices and falling used-vehicle values combine to take a toll on consumers and the industry.
In the first quarter of 2017, the percentage of trade-ins on new-vehicle sales that had negative equity reached a record 32.8 percent. The average amount of negative equity, at $5,195, was also a high, Edmunds data show.
Average negative-equity amounts have exceeded $4,000 on average since the third quarter of 2013. The higher levels came as the economy recovered after the recession, according to Ivan Drury, Edmunds’ senior manager of analytics development.
From 2009-11, negative equity fell “simply because people couldn’t get a new-car loan,” Drury said. As vehicle financing dried up during the downturn, many consumers were forced to hold onto their vehicles, so they paid down more of their balance. “When they finally went to the dealership,” he said, “they didn’t owe nearly as much.”
Now that most consumers have recovered from the recession, they are more likely to trade in their vehicles earlier, often before their loan terms expire. The practice contributes to higher amounts of negative equity.
Consumers are stretching their loan terms as they strive for the lowest possible monthly payment. The average new-vehicle loan term in the first quarter was 69 months, up five months from the first quarter of 2011, Edmunds data show.
Loans lasting 73 to 84 months have also increased, according to Experian, making up 32.1 percent of new-vehicle loan share in the fourth quarter of 2016, compared with 29 percent a year earlier. On the used-vehicle side, loans lasting 73 to 84 months accounted for 18 percent of the share, up from 16 percent a year earlier.
Moreover, there has been upward movement within the 73-84-month loan segment, according to Melinda Zabritski, senior director of automotive finance at Experian. “Years ago, when you saw lenders starting to move into that category, they were on the low end of it,” between 73 and 75 months, she said. “Now we’re seeing a shift within that category of more loans truly being written at 84.”
Despite carrying loans that can extend to the better part of a decade, many consumers continue to trade in their vehicles every few years, leading to higher negative-equity amounts.
“Think about the way the principal and the interest accumulates over a 60-month loan, or a 66 or 72 [month] loan,” said Cheryl Miller, vice president of lender solutions at Dealertrack. “The equity the consumer is building from a principal perspective is [lower] than it is on a shorter duration loan.”
If consumers are accustomed, say, to a five-year trade-in cycle but extend their term to six years and beyond to keep the monthly payments low, they are “getting caught in this vicious cycle,” Drury said.
Economic conditions including low gasoline prices, low unemployment rates and pent-up demand have been apt for consumers to purchase vehicles over the past few years. In 2016, U.S. light-vehicle sales reached a record 17.5 million. Big demand especially for the latest vehicle technology and for pricier rides such as trucks and SUVs has driven up transaction prices. The average transaction price on a new vehicle rose to $34,802 in the first quarter, up 3.8 percent vs. the year-earlier period, according to Edmunds. Compared with the first quarter of 2012, the average new-vehicle transaction price has jumped 15.6 percent.
The trend toward higher transaction prices is contributing to negative equity, Drury said.
“A lot of people are trading up to more expensive vehicles. That is part of the problem,” he said. “Every single year we see [the average new-vehicle transaction price] going up. Financing extends longer.”
The technology “is definitely a game changer,” he added. “Like anything, if you can afford it, you’ll do it.”
Falling used-vehicle values are also hurting customers’ equity positions at trade-in. Used values have taken a hit as off-lease vehicles and trade-ins saturate the market. The Black Book Retention Index showed 27 months of nearly continuous used-vehicle pricing declines from January 2015 through March 2017.
Lou Loquasto, auto finance leader at Equifax, pointed to falling used-car values, higher new-vehicle transaction prices and larger loan amounts as the primary drivers of negative equity. Those factors influence negative equity more than aggressive lending, he said.
Overall, those factors, along with long loan terms misaligned with early trade-in cycles, have propelled the industry to the record average negative equity amount.
“I’ve got rising car prices. I’ve got declining trade-in value. My consumer is still putting down some kind of down payment but wanting to trade in at the same cycle, causing negative equity to rise a bit,” Dealertrack’s Miller said.
Still, negative equity feels manageable, she said. “It’s not like the largest percentage of the population that is trading in cars [is] in a negative-equity situation.”
But at above $5,000 on average, Drury said, it’s worth keeping an eye on.