Can leases cure the car-buying market?

With April vehicle sales in free fall, carmakers have been playing the 0% financing card, offering interest-free payments for as long as seven years. General Motors , for one, is promoting 0% financing for 84 months on the Chevrolet Equinox and GMC Canyon, among other models. Ford has a similar offer on the F-150, while Fiat Chrysler Automobiles is touting 0.9% interest for 84 months on the Dodge Durango R/T. Nissan and Toyota have five-year, 0% offers available on various models, and some OEMs have even sweetened their deals with bonus cash. So far, the offers have been working to lure buyers. In April, a record 25.8% of new-vehicle purchases were financed at 0% interest, and many of the loans had 84-month terms, according to Edmunds . An alarming statistic, though, is that the number of trade-ins bogged down by negative equity spiked to 44% last month. For the past three years, purchases with upside-down trade-ins hovered around 30%, and the rate was closer to 15% in 2011, according to Edmunds. So, while OEMs made progress jump-starting sputtering car sales, they are creating a negative-equity situation that could reverberate through the industry for the next several years. Take, for example, a $30,000 vehicle purchased at 0% interest for seven years. We’ll roll in $5,571 of negative equity — April’s average, according to Edmunds — and we’ll assume the vehicle depreciates 20% in the first year and 10% in each following year. At the end of year one, the vehicle will be worth $24,000, yet the consumer will owe $30,066. Even at 0% interest, it will take nearly four years for the consumer to build some equity in the vehicle. Note, too, that the loan would require a $423-a-month payment. With those numbers in mind, leasing appears to be a stronger near-term option for the auto finance industry. In a nutshell, payments are lower and terms are shorter for leases than they are for loans. For instance, a consumer could lease a 2020 Chevrolet Equinox for $275 per month, compared with $359 per month for a 0% loan, a more palatable option for consumers facing shaky job situations and an uncertain economy. True, the lease would require a $2,775 down payment — equivalent to about 10 months of payments — but the overall term would last only 39 months, less than half of the 84-month loan term. Financiers might consider encouraging potential car buyers to use their stimulus checks or tax refunds to cover the down payment. Consumers will likely be more comfortable agreeing to a commitment that lasts 39 months than one that extends for 84 months. Plus, the shorter term of a lease is a better tool for getting consumers back into the car market sooner. Consumers have become increasingly more comfortable with leasing. Last year, 25.2% of the vehicles in financiers’ portfolios were leases, compared with 15.7% in 2010, according to Big Wheels Auto Finance Data . On a dollar basis, lease outstandings shot up to $306.9 billion in 2019 from $105.3 billion in 2010. Historically, captives have been the primary providers of leases, with the goal of making their OEMs’ vehicles as accessible as possible to consumers. Yet, given the current car-buying environment, perhaps non-captive financiers should explore leasing options. Though somewhat rare, used-car leasing has been around for decades. A used-car leasing program built on conservative residual value estimates could open doors for lenders grappling with stalled vehicle purchases. The tricky part with any leasing program hinges on forecasting residual values. But with used cars, at least 30% of the expected depreciation has already occurred. And though vehicle values industrywide have hit the skids in recent months, they will likely be on the upswing two or three years from now when these leased vehicles reach their end of term. After the Great Recession, the Manheim Index bottomed out at 98.0 in December 2008. Yet, by yearend 2010 it had gained 26.9%, restoring the index to 124.4. So even if lessors are conservative with residual estimates now, they are likely to see auction gains when these vehicles are returned in 2023. The key right now is to trigger vehicle sales without creating too much collateral damage. Leasing is a perfect opportunity.

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