The used cars will go on sale at a dealership on July 11, 2023 in Chicago, Illinois.
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The head of one of the country's largest auto finance lenders isn't too worried about rising consumer auto debt and inflated used car prices leading to longer loans for vehicle purchases.
Your main reasoning? The percentage of income consumers spend on their vehicles has remained relatively stable compared to 2019, before the coronavirus pandemic led to inflated prices as demand increased but inventories remained low.
“If I just told them, 'Car prices are going up, interest rates are going up, insurance prices are going up,' they would say, 'You know what? Consumers should be paying more as a proportion of income.'” capital one Auto president Sanjiv Yajnik told CNBC. “However, if you look at each quintile of people's wages and income, the pay-to-income ratio has remained fairly stable.”
While Capital One reports that average monthly payments for car ownership have increased from $390 to $525 since 2019, data provided exclusively to CNBC from its automotive unit suggests that vehicle costs have remained relatively stable compared to revenues. That's because the pay-to-income ratio has generally remained stable at about 10% since 2019, according to the U.S. bank's automotive division.
Capital One Auto found that 80% of car buyers who finance a vehicle are below the generally recognized 15% pay-to-income threshold.
“The consumer is being cautious. They're being responsible. This is 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 the vehicle for transportation, including work.
However, to achieve that goal, more consumers are taking out longer-term loans to keep payments affordable.
The auto finance veteran's opinion contrasts with others in the industry who see longer-term loans as a detriment to consumers' pockets.
They contend that so-called “permanent loans” of six years or more have led many buyers, particularly of new vehicles, to run out of equity in their cars and trucks. That 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 that involved a trade-in vehicle had negative equity this year through April. The amount of negative equity averaged $5,105, a 35% increase from 2019.
“As the average length of loans increases, the pace at which consumers make progress on paying down their balance slows,” Jessica Caldwell, head of analytics at maxcar's Edmunds, wrote in a recent online post. “If consumers trade in their vehicle too soon for any reason, they will increasingly be left with loan debt.”
Regarding new vehicle financing during the first quarter, 90.2% of new vehicle loans involving negative equity trade-ins had terms of at least 72 months and 43% were extended to 84 months, according to Caldwell. The average negative equity trade-in was $7,183 during the quarter for new vehicles, according to Edmunds.
Those numbers have been rising since 2022, when inflated used vehicle values caused by a pandemic-driven chip shortage prevented more buyers from loading debt on their next vehicle.
According to Yajnik, consumers need to keep their vehicles longer to make long-term loans worth it. But that can also cause increases in maintenance costs, as well as the likelihood that a vehicle will need repairs that exceed its value or have to be scrapped entirely.
“Yes, it takes longer to get the capital, but in the meantime, you can use the car and you're making money,” said Yajnik, a 28-year Capital One veteran who has led the auto lending division since 2008.
The average listing price for a used vehicle was $25,390 in March, according to the most recent data from Cox. That compares to new vehicles, which depreciate faster, at $48,667.
Cox Automotive reports that, all other things being equal on a loan, financing a $30,000 vehicle at a 9% APR would cost $3,100 more over 84 months than a 48-month loan. However, there is a $264 difference in monthly payments, which Yajnik said makes it more affordable for many consumers, especially those at lower income levels.
“Obviously there will be sectors that will have problems, but you have to start from a different place, that is, why do people buy cars and do it irrationally?” Yajnik said.
