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Lenders in America’s $1.2tn car-loan market are extending terms for as long as eight years, meaning they face a greater risk of defaults and meagre recovery values.
Banks and non-banks have entered the market in recent years, looking to increase exposure to a sector that was resilient during the financial crisis. But analysts fear that many have relaxed terms for borrowers too much, particularly in the subprime segment, where losses have historically been much greater.
Also, monthly repayments for borrowers have hit an all-time high, according to Experian, with rising interest rates being passed on to consumers. The average term on new car loans stood at 67 months — or five and a half years — at the end of 2017, according to data from the Federal Reserve Bank of New York, having steadily risen since 2008.
A small number of new loans are being extended out to between 85 and 96 months — or eight years — according to Experian data. For subprime car loans bundled into asset backed securities, the average term has reached a post-financial crisis high of 68.6 months, according to S&P Global.
The longer the loan term, the greater the risk that borrowers find themselves in financial trouble, unable to pay it back. The value of cars that secure a loan depreciates sharply, reducing the ability of lenders to recoup losses if they have to repossess and sell the vehicle. “There clearly is more opportunity for defaults,” said Jonathan Smoke, chief economist at Cox Automotive.
“The longer a loan, the more likely it is going to be underwater for the duration of a loan and the higher probability of a job loss or health problem causing a household to fall behind on payments.” Last year’s hurricanes also supported prices by destroying hundreds of thousands of vehicles, forcing consumers to replace them.
There is also the prospect of used-car prices falling more sharply than usual this year, due to a glut in wholesale markets caused in part by vehicles coming off lease contracts. Black Book, a research firm, expects prices of vehicles aged from two to six years to drop by 17 per cent this year, slightly ahead of the 16 per cent norm and up from 13 per cent in 2017.