Consumers with auto loan terms of six years or longer are twice as likely to end in default when compared with borrowers with loan terms of five years, the Consumer Financial Protection Bureau found in its latest quarterly consumer credit trends report.
Since 2009, loans with 72-month terms or longer (extended term loans) have had default rates exceeding 8%, whereas terms of 60 months or less had a default rate of roughly 4%, the bureau found.
Furthermore, those longer term loans are being extended to consumers with lower Fico scores. Borrowers with six-year terms had an average Fico score of 674, compared with an average Fico of 713 for consumers with five-year terms.
It’s no secret in the industry that loan terms have been growing longer, but many have argued it’s often to higher credit consumers. For example, Citizen Bank’s Head of Auto Lending Craig Lamp told AFN earlier this year that its pool of 84-month loans are some of the best performing in its book.
However, the CFPB’s data shows that subprime and near-prime consumers are in fact concentrated in extended-loan term buckets. Additionally, six-year terms have come to make up a plurality of all loan lengths and extended terms made up 42% of all originations in 2017 so far, compared with 26% in 2009, the bureau found.
There’s been a reluctance in the industry to admit that lenders are using extended terms to place consumers in more expensive cars, however, that’s exactly what’s happening according to the data. A five-year contract had an average loan amount of $20,100, a six-year loan averaged $25,300, and seven-year terms were significantly higher at $32,000.
“These increased amounts may be the result of consumers buying more expensive cars, making smaller down payments, or otherwise financing larger loan amounts by including additional warranties or products in their auto loan,” the CFPB wrote.
Extended loan terms have kept monthly payments down even as the average loan amount has increased, leaving many to fall into negative equity situations. Around 45% of consumers trade in their vehicles and roughly a quarter of them have negative equity, Edmunds.com told AFN earlier this year.
While increasing the term doesn’t drastically increase a consumer’s interest payments, it does put them in a worse negative equity scenario. A borrower paying off a $20,000 loan over six years will pay about $152 more in interest payments than if they had taken out a five-year term. Additionally, the remaining balance on the vehicle will be $2,000 higher under a six-year contract when compared with a five-year term.
“The move to longer term auto loans is opening up more risk for consumers,” Richard Cordray, director of the CFPB, said in a press release. “These loans are more expensive and can result in consumers continuing to owe even after they are no longer driving their car. Consumers should know before they owe and shop for the best deal based on costs incurred over the life of the loan.”