Has the U.S. auto lending market become overheated? The answer depends on which parts you inspect after popping the hood.
Auto finance is definitely booming, but to sustain the growth, auto lenders have made it easier for car shoppers to qualify for a loan. And longer terms that make payments more affordable also increase the chances that the lender will take a big loss.
But whether the easing of credit standards represents a worrisome omen or a healthy return to the pre-recession norm is a matter of intense debate. Here's the case for pessimism about the auto finance market, followed by the argument for optimism.
Why Be Worried?
Historically, auto loans have carried maximum loan terms of five years. Today, 72 months is the most common term for both new and used car loans, according to Experian. Longer loan terms open lenders to the possibility of larger losses when loans go bad.
A report by the Office of the Comptroller of the Currency found lenders are less protected when borrowers default than they used to be, and that the increased appetite for risk is beginning to have negative consequences. "Average charge-off amounts are higher across all lender types over the last year," the report states.
Bob Piepergerdes, the OCC's director for retail credit risk, noted that used-car values are currently at elevated levels, based on historical standards, which adds another element of risk. "You have loans based upon higher used-car values that may or may not hold together over the term of the loan," he says, noting that lenders report that competition is compelling them to loosen their credit standards. The situation carries certain echoes of the housing bubble of the 2000s.
Why the Fears May be Exaggerated
One key reason why investor demand for securitized auto loans has been so strong is that the sector weathered the financial crisis quite well. That history bodes well for the future.
"Consumers need automobiles, and that was proven in the recession," says Mike Buckingham, senior director of the automotive finance practice at J.D. Power. "That was the No. 1 debt that was paid by the consumer."
And despite the loosening credit standards in recent months, auto loan delinquencies have not risen appreciably. For auto loans originated in May through July of last year, only 1.4% were 90 days or more past due in the subsequent months, according to Fair Isaac.
And there are limits to the parallels between today's auto sector and the housing bubble of the mid-2000s. For example, auto lenders don't make interest-only or negative amortization loans.
