Our household has a simple strategy for autos. My wife always gets the new car, the old one ages to me. There is no fighting, I can drive her car when I need to, but the thought of paying a car payment scares me more than credit card debt. The reason is simple: why pay on a depreciating asset?
An article in today’s WSJ covers a shift in auto finance that should ring a chord with most of America.
- The average loan stretches for roughly 69 months, a record. Some last much longer. In the first half of the year, 1.5% of auto loans for new vehicles had terms of 85 months or longer, according to Experian. Five years ago, these eight- and nine-year loans were practically nonexistent.
The driver is clear: the auto sales business model has changed. More money comes from financing a car than selling it.
- So far this year, dealerships made an average of $982 per new vehicle on finance and insurance versus $381 on the actual sale, according to J.D. Power, a data and analytics company. A decade earlier, financing brought in $516 per car and the sale made dealers $837.
Compared to the Riley-household model, which never finances more than ¼ th of the purchase price, before recycling the car to the next user (me), the American consumer enjoys a flashing new car even as the loan has not yet been paid off. Call me cheap, but I sleep well at night.
- As a result, a growing share of car buyers won’t pay off the debt before they trade in their cars for new ones, either because the car is in need of repairs or because they want a newer model. A third of new-car buyers who trade in their cars roll debt from old vehicles into their new loans, according to car-shopping site Edmunds.
The issue here is easy money. The reason: asset-backed securitizations. You can get into the gory details on ABS in this recent Mercator Advisory Group report.
- Americans have been borrowing to buy their cars for decades, but auto debt has swelled since the financial crisis. U.S. consumers held a record $1.3 trillion of debt tied to their cars at the end of June, according to the Federal Reserve, up from about $740 billion a decade earlier.
- Finance managers at dealerships typically use an electronic portal to hash out the terms of the loans. On the other end are various financial institutions that buy up the loan pretty much as soon as the dealer closes the deal.
- Banks and credit unions are big lenders, as are the finance arms of major car makers. Some of these lenders shunned riskier subprime borrowers after the financial crisis, fueling the growth of independent nonbank auto lenders.
- Westlake Services LLC is among the biggest. Its owner, billionaire Don Hankey, started lending four decades ago when, as a dealer, he realized subprime buyers needed somewhere to get their financing. Westlake is still focused on these borrowers, but it has pursued more creditworthy customers as it has grown in recent years.
- Much like a dealership, the company is obsessed with results. An automated system sends emails to employees with an image of a winking robot when they are late to work, unproductive or exceed expectations. Workers get monthly bonuses based on how they stack up against their goals. Screens around the office display auto loan applications as they come in.
- Westlake needs to make sure the monthly payments on its auto loans keep flowing. Late borrowers can expect calls from the company immediately. Roughly 40% of its employees focus exclusively on collecting.
Our household strategy works better. A minimal loan, for less than ¼ of the total car, as we did when we purchased our 2019 pimped out Nissan Rogue. It is hers for now; it cascades to me in about 2024.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group