Used car available for sale at our Chicago, IL dealership on July 11, 2023.
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The head of one of Japan’s largest auto lenders isn’t too worried about the rise in consumer auto debt and soaring used car prices, which are leading to longer vehicle purchase loans.
What is his main reason? The share of income consumers spend on cars was relatively flat compared to 2019, before the coronavirus pandemic caused demand to surge but inventories to remain low, leading to soaring prices.
“If I said, ‘Car prices are going up, interest rates are going up, insurance prices are going up,’ you’d say, ‘Look, consumers must be paying more for their income.'” capital one Automotive President Sanjiv Yajnik told CNBC. “But when you look at people’s salaries and income quintiles, the pay-to-income ratio remains roughly flat.”
Although Capital One reports that the median monthly car title payment has jumped from $390 to $525 since 2019, data provided exclusively to CNBC from the company’s auto division suggests that car costs have remained relatively stable compared to income. That’s because, overall, the payment-to-income ratio has remained flat at about 10% since 2019, according to the auto division of American banks.
Capital One Auto found that 80% of car buyers who finance their vehicles spend less than the commonly recognized pay-for-income threshold of 15%.
“Consumers are being cautious and they’re being responsible,” Yajnik said, referring to consumers prioritizing car payments for transportation, including work. “This is a much healthier way to do it than it would otherwise be because it’s not a discretionary expense.”
But to achieve that goal, more consumers are taking out longer loans to keep their payments affordable.
The auto finance veteran’s view stands in contrast to others in the industry who think long-term loans hurt consumers’ pockets.
They claim that so-called “permanent loans” of six years or more have caused many buyers, especially new vehicle buyers, to lose equity in cars and trucks. This means that when you trade in your car, you end up owing more than the car is worth.
Edmunds reports that through April of this year, approximately 26% of used cars purchased, including trade-ins, had negative equity. The average amount of negative equity was $5,105, an increase of 35% from 2019.
“As loan terms grow on average, consumers pay down their balances at a slower pace,” says Jessica Caldwell, director of insights. carmaxEdmunds wrote in a recent online post. “Then, if for any reason the consumer trades in their car too soon, they are left with more and more loan debt.”
For new car financing in the first quarter, 90.2% of new car loans with negative equity trade-ins had terms of at least 72 months, with 43% extending to 84 months, Caldwell said. The average negative equity trade-in value for new cars in the quarter was $7,183, according to Edmunds.
This number has been on an upward trend since 2022. That’s because a chip shortage caused by the pandemic has sent used car prices soaring, leaving more shoppers unable to afford debt on their next car.
Consumers need to keep their cars longer to get the value of long-term loans, Yajnik said. But not only can it cause increased maintenance costs, it can also require repairs that exceed the vehicle’s value, or even have to be scrapped entirely.
“Sure, it takes time to get the equity, but in the meantime you can use the car and make money,” said Yajnik, a 28-year Capital One veteran who has led the auto financing division since 2008.
The average list price for a used car in March was $25,390, according to the latest data from Cox. That compares to $48,667 for a new car, which depreciates more quickly.
Cox Automotive reports that an 84-month loan costs $3,100 more to finance a $30,000 car at a 9% annual interest rate than a 48-month loan, all other things about the loan being equal. However, there is a $264 difference in monthly payments, making it more affordable for many consumers, especially those in low-income brackets, Yajnik said.
“Obviously there are going to be areas that have problems, but you have to start somewhere else. That is, for what reasons do people buy cars, and are they doing so irrationally?” Yajnik said.
