Source: Yahoo Finance

Strong car sales today could trigger the next downturn – Yahoo Finance

5 months ago Comments Off on Strong car sales today could trigger the next downturn – Yahoo Finance

A bubble may be forming in the car market – but not the one doomsayers are worried about.

With nearly 25% of auto loans going to borrowers with subprime credit, some investors fret that a wave of defaults could be coming, similar to the subprime mortgage crisis that caused the worst housing bust in a century, starting about a decade ago. But subprime default rates on cars are low and such loans weren’t a problem even during the financial crisis that began in 2008.

Almost unnoticed, however, has been a surge in overall auto lending, with new record highs for the average price paid for a car, the average amount of a loan and the average monthly payment. To manage that debt, lenders have stretched the average duration of a loan to 68 months, the longest on record. “A longer loan lowers the monthly payment and makes that vehicle more affordable,” says Melinda Zabritski of credit-analyis firm Experian. “The risks are, you’ll pay more interest and your total cost will be higher.”

American consumers now hold more than $1 trillion in automotive debt, another record high. There’s nothing inherently risky about more automotive debt. But current financing trends spell trouble for automakers, because future car buyers will have negative equity in their current vehicles – owing more than the vehicle is worth – longer than ever. There’s a good chance that will depress sales when buyers find they can’t buy a new car unless they come up with several thousands dollars to pay off what they still owe on the old one.

The auto industry is in full gallop at the moment, with sales running at a strong annualized pace of about 17.5 million. Sales of trucks and large SUVs are soaring, aided by cheap gas. Hot new crossovers like the Honda CR-V, Hyundai Tucson and Mazda CX-5 have cut into sales of economy cars, usually bringing higher profit margins. The average buyer pays $33,845 for a new car, according to Kelley Blue Book – 3.5% more than a year ago. The average loan amount is $30,032, according to Experian, for an average monthly payment of $503.

Car buyers care most about those monthly payments, and to keep them manageable, lenders have extended the average length of a loan from 64 months in 2008 to 68 months now. Some loans run for eight years or even longer, for unusual specialty vehicles. Easy lending and flexible terms – sometimes financed by automakers themselves – helped the car business recover from the 2008 downturn much faster than the housing market, where underwriting standards for mortgages remain strict.

But the cure for the last downturn could cause or contribute to the next one. “With more buyers in longer loans, you won’t get this rapid turn at 36 or 48 months,” John Mendel, executive vice president of American Honda, told Yahoo Finance recently. “There’s a concern that it will cost more to trade in the car, so they’ll probably keep it.”

Another factor could exacerbate that problem. Leasing is also at record-high levels, which is great today because it allows more people to obtain a new car, but will flood the market with used vehicles in a few years, when those cars come off-lease and get turned back in to dealers. That will likely have two effects. First, it will create a glut of late-model cars available to buyers in lieu of used cars. And second, that boost in supply will push down the value of used and new cars both. For owners with long-duration loans, that could extend the date at which they have positive equity in their vehicles and delay the purchase of a new car even longer. One important upside: “Twenty-four and 36 months from now, it will very much be a used-car buyer’s market,” says Zabritski.

For now, automakers are rolling in profits and enjoying good times. But investors are spooked about the future. Despite strong sales, for instance, shares of General Motors (GM),Ford (F) and Toyota (TM) have underperformed the broader market during the last year, with shareholders concerned that car sales are at a peak and the best years are behind them. The rise of ride-share services such as Uber and car-share companies such as Zipcar bring additional worries for old-line automakers. Automakers have always found clever new ways to move the metal in the past, and they’ll have to do so again.

Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.

Strong car sales today could trigger the next downturn – Yahoo Finance}