Used cars are offered for sale at a dealership on July 11, 2023 in Chicago, Illinois.
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The head of one of the nation’s largest auto finance lenders isn’t too concerned about rising consumer auto debt and rising used car prices, which are leading to longer loan terms for vehicle purchases.
His main reasoning? The percentage of income consumers spend on their vehicles remained relatively stable compared to 2019, before the coronavirus pandemic led to higher prices as demand increased but inventories remained low.
“If I simply told you, ‘Car prices are going up, interest rates are going up, insurance prices are going up,’ you would say, ‘You know what, consumers have to pay more in proportion to their income.'” Capital one Automotive President Sanjiv Yajnik told CNBC. “However, when looking at each wage and income quintile, the payment-to-income ratio has remained fairly stable.”
While Capital One reports that median monthly payments for car ownership have increased from $390 to $525 since 2019, data provided exclusively to CNBC by its auto unit suggests that vehicle costs have remained relatively stable relative to income. Indeed, overall, the payments-to-revenue ratio has remained stable at around 10% since 2019, according to the American bank’s automotive arm.
Capital One Auto found that 80% of car buyers who finance a vehicle fall below the generally accepted 15% payment threshold.
“The consumer is cautious. They are responsible. It’s a much healthier way of doing things than the alternative, because it’s not a discretionary expense,” Yajnik said, referring to consumers who prioritize paying for a vehicle over transportation, including work.
However, to achieve this goal, more consumers are taking out longer-term loans to keep payments affordable.
The auto finance veteran’s view contrasts with others in the industry who see long-term loans as damaging to consumers’ wallets.
They say so-called “lifetime loans” of six years or more have led many buyers, especially of new vehicles, to find themselves underwater on the equity in their cars and trucks. This means they owe more than their vehicle is worth when they decide to trade it in.
Edmunds reports that about 26% of used vehicles purchased involving a trade-in had negative equity this year through April. The amount of negative equity averaged $5,105, an increase of 35% from 2019.
“As the average loan term increases, the pace at which consumers make progress paying off their balance slows,” Jessica Caldwell, head of analytics for CarMax‘s Edmunds, wrote in a recent online article. “If consumers trade in their vehicles too early for any reason, they find themselves in more and more debt.”
Regarding new vehicle financing in the first quarter, 90.2% of new vehicle loans involving trade-ins with negative equity had a term of at least 72 months, and 43% extended up to 84 months, according to Caldwell. The average negative equity recovery was $7,183 during the quarter for new vehicles, according to Edmunds.
Those numbers have been climbing since 2022, when inflated used vehicle values caused by a pandemic-fueled chip shortage kept more buyers from taking on debt for their next vehicle.
Consumers need to keep their vehicles longer to make long-term loans worth it, according to Yajnik. But it can also lead to increased maintenance costs as well as the likelihood that a vehicle will require repairs beyond its value or need to be scrapped altogether.
“Yes, it takes longer to get your equity, but in the meantime you can use the car and you make money,” said Yajnik, a 28-year Capital One veteran who has led the auto lending division since 2008.
The average list price of a used vehicle was $25,390 in March, according to the most recent data from Cox. This compares to new vehicles, which depreciate more quickly, at $48,667.
Cox Automotive reports that if all else is equal for a loan, financing a $30,000 vehicle at a 9% APR would cost $3,100 more over an 84-month term than a 48-month loan. However, there is a $264 difference in monthly payments, which Yajnik says makes it more affordable for many consumers, especially those in lower income brackets.
“There will obviously be pockets that have problems, but you have to start from a different point, which is why are people buying cars, and are they doing it irrationally?” » said Yajnik.