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As used-car loan lengths increase, so does risk for borrowers, lenders

January 6, 2012
Following the trend of vehicles staying on the road longer, so too are used-car loan terms getting longer. That’s in part because pre-owned vehicles are in demand today, keeping their residual values strong. They also last longer because of quality improvements in recent years compared with their relatively short-lived predecessors.
And lenders have become more competitive. Five-year loans on 4-year-old cars could come soon “because of high used-car prices and aggressive lenders,” said Ricky Beggs, managing editor of Black Book, an auto-pricing guide.
Pre-owned vehicle loans typically are shorter than those for new cars. Financial institutions can balk at extending payback terms too far out for older vehicles that have been around the block more than a few times.
“Long-term used-vehicle loans are risky propositions,” said Jonathan Banks, an auto analyst for the National Automobile Dealers Association. “They are like vehicle leasing; it’s a great tool until you go too deep.”
Led by banks, financial institutions have accelerated their auto lending, in contrast to putting the brakes on much lending during the financial crisis of 2008-2009.
“They are buying deeper to get greater market share,” said John Gray, Experian Automotive’s vice president-sales. “They are offering more-aggressive terms and attractive rates.”
The average prime rate on used-car loans is 5.5 percent, compared to 3.7 percent for new vehicles, according to Experian. The subprime rate average for used cars is 13.1 percent  and 8.5 percent for new vehicles.
“Banks are going after those longer used-car loans,” Banks said at a recent National Remarketing Conference. “They are scooping up as many as they can.
“But if you have a 3-year-old vehicle and push the loan out five years, it’s an 8-year-old car by the end of the loan. There is a point where the depreciation becomes rapid.”
When that happens, the amount of the outstanding debt becomes substantially greater than the value of the vehicle. It’s a risky proposition for both borrowers and lenders.
Today’s long-term lenders depend a lot on the greater reliability of today’s cars because major maintenance problems can spark credit defaults, especially by at-risk borrowers. An adage of the business is that if a subprime customer’s car stops running, chances are the payments will stop too.
Consumers who opt for longer loan terms tend to have lower credit scores, Gray said.
In the first half 2011, the average credit score for people with a 73- to 84-month auto loan was 709, according to Experian. In 2009, the average score was 730.