Are Car Loans Killing The Auto Business?

A record number of Americans can’t pay them. What can competitive dealers do to maintain their advantage?

According to a recent study from the New York Federal Reserve Bank, at the close of 2018 over 7 million Americans were three or more months behind on their auto loans, putting them at risk of repossession. Add that to rising and longer-lasting amounts of student debt and an increased cost of living, and it’s no surprise that more and more Americans are having trouble financing a car purchase.

Which begs a question of auto dealers: Should the auto loan remain a top-of-mind option for your customers?

Auto Debt Levels Are Insane

We know. It seems crazy to question a financial underpinning that’s been so crucial to the growth of the auto industry over time. But auto loans weren’t always so central to the car business — and the reality is that changing consumer preferences could very well make that a reality again.

In 1970, Americans held just $36 billion in auto loans. These days, Americans are reckoning with $1.27 trillion in auto loan debt, while a record number of people can’t even afford to make their payments. Meanwhile, the length of the average auto loan has ballooned to 69 months — eight months longer than in 2010 — while the average monthly payment has hit $551.

This reality also touches dealers, who could find it harder to sell loans as a compelling way to access a vehicle in the face of more flexible options.

Bill Westrom, co-founder of Truth in Equity and author of Master Your Debt, said today’s auto debt problem is part of a troubling trend that only seems to be getting worse.

“The financial balance of the conventional model of banking and borrowing is proving itself to be extremely out of balance,” Westrom said.

The Young & The Cashless

This problem, while significant, is not yet having a big impact on F&I offices at the largest public dealership groups, which have been posting record high returns as of late. But the prospects of maintaining that momentum look dim when the people struggling the most with auto loan debt are those under 30 years old, as the Fed study revealed.

In fact, around 4 percent of people aged 18–29 with auto loans are now in serious delinquency, up from a low of around 2.5 percent in early 2014. That’s a pretty scary trend for delinquency rates — especially considering those customers represent the future of the auto industry.

Tighter Requirements, Rising Interest

To address the problem, lenders have started enacting tighter financing requirements as a way to stave off higher auto loan delinquencies.

In an opinion column for The Hill, Cox Automotive’s lead economist Jonathan Smoke cites consecutive increases in the minimum required credit score for five quarters in 2016 and 2017 and an increase in minimum down payments as a reaction to this trend.

“Defaults have been declining as a result,” he says.

But these same strategies could also reduce the number of people who can finance a car in the first place, thus hurting sales. In fact, there have been notable declines across almost all categories of car sales in 2019 (although, of course, correlation does not equal causation).

Also compounding the problem are the recent spate of interest rate increases. There were four interest-rate hikes in 2018 alone, which have made it harder for dealers to offer the incentives they have in the past, including fewer zero-percent financing promotions.

What Should Dealers Do?

We would argue that, for an increasing number of Americans, the old-fashioned world of auto finance simply isn’t working, as evidenced by today’s higher delinquency rates and ballooning auto debt.

The solution may well be a subscription-style service that allows your customers to access a car on a flexible basis — without the long-term commitment or debt-based nature of an auto loan.

For example, dealers can become a Fair partner at no cost at all, enabling customers to shop your inventory on their phone by monthly payments designed to fit their budget, sign for the vehicle they want with their finger, and drive it for as long as they want.

Not only does Fair pay your dealership the full price of the vehicle when a customer selects it on the app, but it also gives the customer the opportunity to re-enter the auto market with more frequency since they aren’t tied to paying off a multi-year loan.

It’s a modern solution to the very modern problem of auto debt — and the kind of shift that Westrom said sellers need to make to adapt to a new class of modern consumer.

“If you want better financial results you have to operate a better model,” Westrom said.