If you follow the car industry, you know that in the past two years, a lot of red flags have been raised about loosening auto-lending standards.
At first, all the worry was focused on so-called “subprime” loans, in which the borrower has a less-than-great (but often not terrible) credit score — basically, anything under a 640 FICO, with truly “prime” being borrowers who are in the 750 ballpark.
Comparisons were made with the housing-market meltdown, but subprime home lending and subprime auto lending don’t match up: the housing market was, and is, vastly larger than the auto market, and nobody finances a Buick for 30 years.
When the auto-lending market didn’t collapse but actually expanded, the worrying shifted to extended loan terms. Lenders were stretching loans out past the typical 5-years, to lower consumers’ monthly payments.
But defaults across the auto-lending sector in the US are still low, so the worry has now moved on to the more arcane realm of owing more on a car than it’s worth. Here’s the Bloomberg’s Chris Bryant:
Negative equity. Amid the global financial crisis, it spelled misery for millions of U.S. homeowners as the outstanding balance on mortgages exceeded resale prices. Now, it’s shifting to another credit-addicted sector: the car market. Almost one-third of U.S. vehicles traded in this year were in negative equity, according to JD Power data. That puts a heavy burden on consumers and it’s an unhappy signal for auto-maker profit.
Except that again the houses-to-cars comparison is tenuous. I own a house, and I expect it to be worth more when I sell it, if I ever do, than it’s worth now. It could slide in value, but over the long haul (30 years), I figure it will roughly match the rate of inflation and maybe do a bit better.
I also own a car. And I expect that car to be worth exactly zero when I get finished using it to move myself around. In other words, I don’t just assume a risk of negative equity — I assume zero equity.
Sure, I’m a bit of an unusual case in that I don’t plan to trade the car in at any point. I run the wheels off my cars and then call the junkyard. I financed a used Saab 900S that was my daily “beater” from 2006 to 2014, paid it off in about 3 years, and sold it for $300 when I moved from California to New York.
But even if you aren’t like me, you’re probably like most car owners, or car leasers, in that you understand what a lousy financial deal an automobile is. You don’t buy or lease a car to make money, or to have an asset of ascending value, or even stable value. You buy a car to get around.
And if you’re worried about trade-in values and what you still have left on your loan, then you can always refinance your auto loan. Or just pay the car off sooner. And if none of those options are on the table, then just hang into the car and accept the cruel logic of total depreciation. At least you have your health.
True, Bryant’s concern is directed more at household and automaker balance sheets, as negative equity needs to be accounted for. And that respect it makes sense for the car companies and their captive-lending arms to trim back at some point on the loans that extend out past 60 months.
But a lot of commentary around auto lending right now suffers from a little too much financial literacy. It’s hugely depressing to write a check every month to pay off a car that, every month, slides in value. But we gladly do it because car ownership provides so much convenience and, for some owners, joy.
We have certainly gotten smarter about credit since the financial crisis. But when it comes to cars, we can get as smart as we want and it won’t make any difference: when you buy an automobile, the price of entry is that you willingly turn of your economic brain.