Another Overextended Consumer Factoid

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Many consumers can’t afford to trade up to new cars. The years and years of Detroit providing heavy financial subsidies has stopped creating incremental sales. And Ford called its sales in April “terrible.” With that as a starting point, how far down can things go?

One reason I imagine this is underreported is New York, where most financial reporters and commentators live, continues to be a bubble disconnected from the rest of the economy. Felix Salmon tells us that the New York City Real Estate Board reported that the price of the average NYC apartment rose 23% last year (and presumably car dealers are doing well too). By contrast, in the mid-Hudson River area, a mere 90 minute drive away, prices, according to my less scientific survey (a call to a broker) are down for the third year running.

From the Chicago Tribune (courtesy Calculated Risk):

John Guido, dealer principal of Arlington Heights Ford, thinks his sales have suffered from a combination of rising car prices and longer loans, leaving fewer buyers in a position to trade for a new vehicle when the new-car itch typically appears after a few years.

“They used to be able to trade after three years. Now it’s four years,” Guido said. “If they owe $16,000 on a car that’s worth $12,000, they can’t get to a payment they’re comfortable with. That could mean a $100 swing” in their monthly payment.

Some days, he adds, his Ford store sees lots of shoppers but doesn’t have many signed contracts at closing time.

“You look at what happened, and you’ve got five or six deals you could have made, but you couldn’t get to the payment they wanted,” he said. “Someone may want to trade out of a big truck for something smaller, but there may not be any way to do it.”

Despite a record U.S. population and more licensed drivers than ever, sales of new vehicles slipped nearly 3 percent last year to their lowest level since 1998 and are down the same amount this year.

Analysts and auto manufacturers cite several factors for the sales slide, including high gas prices, sagging home values and sluggish economic growth.

But those who study car-buying habits see another factor keeping a lid on car sales: the aggressive borrowing habits of consumers today.

They say borrowers have stretched out their car loans over such a long period of time that some can no longer afford to replace their vehicle.

“They would like to trade, but they can’t. They have no equity,” said Art Spinella, president of CNW Marketing Research, which studies consumer buying trends.

Three out of five new-vehicle loans made this year, or 60 percent, are for 61 months or longer, and nearly 20 percent are for longer than six years, according to a Consumer Bankers Association study. Some go as long as 96 months.

That’s a dramatic increase since 2000, when just 21 percent of loans were for longer than five years. A longer loan takes more time to build equity usable for the down payment on the next vehicle, thus causing some buyers to delay a purchase.

“The one thing everyone in the industry should be keeping an eye on is the longer terms. It creates the potential for slower vehicle sales in the future,” said Walter Cunningham, president of Atlanta-based BenchMark Consulting International, a financial-services consulting firm. “Customers who would have bought a new car sooner may not be able to. It’s becoming a factor now and will become more of one in the future. Longer terms mean people aren’t going to buy new cars as often.”

Lenders and automakers say they stretch loans because consumers want to keep their monthly payments affordable.

CNW says the average loan in 2006 was 64.8 months, up from 52.4 in 1998. This year it has climbed to nearly 71 months.

On average, it takes 48 months before a buyer has equity in a 60-month loan and 59 months on a 72-month loan, Spinella said.

Having no equity, or being “upside down” as it’s called in the trade, doesn’t deter all potential buyers. They might stretch out payments even further to keep their monthly note down.

Michael Buckingham, president and chief executive of Hyundai Motor Finance Co., the lending unit of Hyundai Motor America., says longer loans represent a potential threat to sales because most consumers start thinking about a new car after 37 to 42 months of ownership, regardless of how much time is left on their contract.

Hyundai’s average loan is 65 months, and roughly 30 percent are for 72. Buckingham says Hyundai offers 30- and 36-month leases as alternatives to put their customers back in the market sooner.

“We’re concerned about repeat buyers coming back,” he said. “With a lease, a consumer can walk away at the end without having negative equity.”

Ford Motor Credit Co. wrote more new-car loans than anyone last year, more than 850,000, and the average loan was for 61 months. Spokeswoman Christine Solie said this year that one-third of its loans have been for 72 months.

But while Ford sales are down 13 percent this year, Solie said that’s not because buyers are stuck upside-down in long loans.

“There are some customers who want to keep a car a long time and have an affordable payment,” she said of the longer terms.

As loan contacts have lengthened, so has the amount of time that consumers keep new cars. CNW says the average buyer keeps a car 59 months, up from 50 months in 2001. Most buyers would still like to get a new car every four years or sooner, Spinella said, but now fewer can afford to….

Analysts are looking at the impact of long loans on sales because they’ve noticed the long-term decline. In 1990, when the U.S. population was 231 million, vehicle manufacturers sold 13.9 million vehicles, or 6 percent of the population. Last year, when the population hit 300 million and the number of licensed drivers topped 200 million, industry sales of 16.6 million vehicles equaled 5.53 percent of Americans.

If 6 percent of the people had purchased cars last year, the industry would have sold a record 18 million vehicles.

“With the population growth the industry should be doing over 17 million almost as normal,” said Spinella.

North suburban Chevrolet dealer Bill Stasek doesn’t see longer loans keeping buyers from his showroom, but he says there’s no question consumers are signing up for longer terms. Part of that is because manufacturers like General Motors Corp. have lured them with zero percent financing for five years. But he estimates that 60 percent of his customers trade before their current vehicle is paid off.

“Probably 70 percent of our business is for 60 months or more, and 72 months is pretty normal,” he said. “If you’re pulling negative equity, you basically have two choices: a higher monthly payment or extend the term of the loan,” he said, and most choose the latter so their monthly payments don’t go up.

CNW says that in 1998 the average monthly payment was $404. This year it’s $408, but the big difference is that buyers have tacked on 19 months to their loan contracts on average.

Consumer Web site estimates that 27 percent of buyers who trade vehicles owe more than their trade-in is worth, and the average amount of negative equity has climbed to nearly $4,000 this year from $3,270 in 2002.

“Car buying is a very emotional decision and every dealership knows this. That’s why they sell the sizzle, not the steak,” Edmunds senior analyst Jesse Toprak said. “It becomes a fashion issue. Consumers see their neighbor has a certain car, so they decide they have to have a better car.”

Toprak thinks big rebates, still offered mainly by domestic companies, are coaxing upside-down buyers into the market.

“They know that one out of four consumers won’t be able to buy a car without them. Incentives were supposed to be temporary after 9/11, but they’re an integral part of the buying process,” he said.

A buyer who owes $4,000 can use a $4,000 rebate to wipe out his old debt and find banks and finance companies willing to finance the entire cost of the new vehicle. With the average price of a new vehicle around $28,000 that can require stretching the loan to 72 months or longer to keep the payments reasonable.

But Spinella thinks the prospect of paying for a vehicle that long is too daunting for many consumers, and many opt instead for less-expensive purchases, like home improvements or trips to Hawaii.

CNW’s research says 50 percent of consumers who shop for a new vehicle but decide not to take the plunge back away because they decide to buy something else. That is up from 38 percent five years ago and 27 percent 10 years ago.

The second-biggest reason they don’t buy is because their current vehicle is still in good shape.

In 1990, more than 80 percent of vehicle sales were to consumers whose old vehicle was beyond repair or needed repairs that would cost more than the vehicle was worth, CNW says. Today, it’s less than 20 percent.

“If they have $1,000 or $2,000 to spend, they don’t want to pay off their car loan and sign up for another seven-year debt [on a new car], so they buy something else,” Spinella said. “There are many other things they can spend their money on, from home decorating to entertainment systems.”

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