Chris Martin knew he needed a bigger car as the birth of his fourth child approached, but he and his wife were already $14,000 underwater on their two vehicles.
So the couple proposed an unusual two-for-one deal with an Atlanta-area auto dealer in 2020: trading in both of their vehicles so they could afford a three-row Ford Explorer. After factoring in the negative equity on the $49,000 Explorer, a service contract, fees and other costs, their total debt swelled to $66,000.
Despite making great progress on the loan, he feels uneasy. “I don’t want to pay interest on cars I no longer own,” said Martin, a 36-year-old data engineer.
An increase in negative equity – or the amount that the loan is in excess of the vehicle’s value – is unnerving consumers and raising alarms within the industry. While it’s not uncommon for drivers to have negative equity, some dealers say more are reaching $10,000 underwater, or “upside down,” on their trade-ins. They are still buying at skyrocketing prices and taking loans from one car to another and even a third. Loans usually extend for seven years.
“As trade-in values begin to wane, more and more consumers each month will find themselves sliding from positive to negative equity,” said Evan Drury, director of insights at auto-market researcher Edmunds. “Unless American car buyers break their habit of buying again soon, we will see the negative equity tide continue to rise.”
Even if the US economy avoids a recession this year, consumers will struggle to make payments on their auto loans, especially with the Federal Reserve planning to continue raising interest rates. According to Edmunds, the average new car interest rate rose to 6.9% in January from 4.3% a year ago. With car prices still on the rise, demand high and inventory levels relatively low, Ford Motor Co., General Motors Co. and other automakers continue to turn in big profits.
For the typical American, a new car is increasingly out of reach. Today, nearly two in 13 people are making monthly car payments of $1,000 or more. For many people, there isn’t a choice: they have little or no public transportation options and need a car to go to work, get the kids to school, and buy groceries.
“Since these car loans are generally unaffordable initially, this means that every month, borrowers are getting closer to financial edge,” said Kathleen Engel, professor of law at Suffolk University.
The cost of new vehicles has increased by 20% since the start of the pandemic, while that of used vehicles has increased by 37% even after cooling off in the fall. For a brief period, car owners entered a volatile market where they could sell some used cars for more than they paid for them. This helped reduce negative equities earlier in the pandemic.
But as more consumers are draining savings accumulated during the pandemic, they are going underwater again.
For trade-ins with negative equity, the average amount is approaching pre-pandemic levels at $5,500, according to Edmunds data. The rise in prices and the prevalence of 84-month loans is raising concern among consumer advocates and within the auto industry.
Pete Kesterson is the general manager of a dealership in Falls Church, Virginia. There is a Volvo showroom on one side of his lot, and a Kia showroom on the other. He’s much more concerned about customers shopping for Kias — which rely on more hefty financing — than he is for Volvo buyers, who he says often pay cash.
“It’s going to come, and it’s going to bite us,” Kesterson said, referring to negative equities, which he believes will worsen. “Now, we are selling cars for a lot more, and longer financing at a much higher interest rate. There are some challenges coming down the pike.
Negative equity has already bitten Shawna Ballou, a 45-year-old mother of five from Tacoma, Washington, who feels “trapped” in her Ford Escape. Four years ago, he traded in a Chevy Malibu and bought a six-year-old Escape for about $16,000. After including the negative equity in her business, taxes and other fees, she financed over $25,000 and is paying it off over seven years.
She researched the life expectancy of her car, and she’s worried she’ll end up with a car that won’t last.
“I can’t even get someone to refinance me because the value of the car doesn’t increase,” said Ballu, who is working two jobs and trying to start her own business. Has been
The negative equity boom is on the radar of US Consumer Financial Protection Bureau officials. They are now closely monitoring that the safety net of selling a used car to get out of debt is disappearing.
“Increasing used car prices may make consumers less likely to find themselves underwater on a car loan,” said Ryan Kelly, acting auto finance program manager at the CFPB. “That may be changing.”
To respond to higher vehicle costs, lenders have increased the length of auto loans. Companies like Upgrade Inc., which offers auto refinancing, are also tightening the standards of who qualifies for financing—a trend they predict will continue if the job market worsens and rates keep climbing. Are.
Renaud Laplanche, co-founder and CEO of Upgrade, said, “The worsening economic situation combined with the prospects of a continued decline in car prices will make it more difficult for consumers to qualify for the car of their choice. It becomes difficult to do.”
For now, even seven-year loans are doing well, said Margaret Rowe, a senior director at Fitch Group Inc. who focuses on auto financing and asset-backed securities. But if car prices remain high and lenders keep increasing loan terms, opting to offer them to borrowers with lower credit scores, that could change, she said.
In January, critically delinquent auto loans reached their highest rate since 2006, based on Cox Automotive data.
One wild card for consumers is the volatility in used car values. According to the Mannheim Used Vehicle Value Index, after a historic climb during the pandemic, values had fallen 13% from their peak by January, but suddenly climbed again in February. If they fall further, anyone buying at the top of the market will fall further into the negative equity trap.
Subprime consumers with negative equity and looking to buy a second car are particularly vulnerable, said Todd Nelson, senior vice president of strategic partnerships at Lightstream, part of Truist Bank.
“They’re just accumulating debt in a way that isn’t fiscally responsible,” Nelson said. “For the people in that place, if they can afford, they would be far better off staying in that vehicle.”