Why longer loan terms are not a big concern

Collins: The industry is giving customers what they want but doing so in a way that doesn't create huge, terrible lending practices or significant portfolio risk.

UPDATED: 6/18/15 12:59 pm ET

The average auto loan term on a new car has grown to more than five years. And that has some industry watchers worried that extended loans will keep consumers out of the market longer, lead to negative equity and increase default rates.

But Michael Collins, senior vice president of F&I solutions at Dealertrack, isn’t concerned that the trend toward longer loans is necessarily putting the market in danger.

He says there are multiple factors to consider before assessing the risk, such as the collateral, loan value and credit quality of the applicant. He also points out that consumers’ opportunity for low monthly payments is fueling new-vehicle retail sales, which many analysts predict will reach 17 million this year.

Collins spoke last week with Staff Reporter Hannah Lutz.

With the average loan term on a new vehicle stretching to a record 67 months in the first quarter, according to Experian Automotive, how closely should the industry be monitoring loan length?

We don’t see any material changes in term. It’s lengthened a little bit, but we’re talking a hundred basis points or a few hundred basis points of change in the last six or seven years. We’re seeing an increase in term in aggregate across our portfolio of about 3 percent, or a couple of months. A couple of months’ change in the extension of term does not derail the market or derail the industry or impute significant risk going into these transactions.

What about loans as long 73 to 84 months? Experian says loans in that range made up nearly 30 percent of new vehicles financed in the first quarter, up 19 percent year over year.

We actually look at credit quality for term. What we see for credit scores less than 620, which is our definition of subprime, is that terms greater than 72 months only account for about 5 percent of our application volumes.

The increased term beyond 72 months is very, very heavily weighted to prime and superprime. The assumption is there is a gap between the unamortized balance of the transaction when the customer wants to bring the car back and get a new one and what that car was actually worth. With a credit score over 660, I think there’s an assumption implicit in the lender’s approval that that customer can afford it.

I don’t think you can just look at term and make conclusions. You really have to look at each one of these key performance indicators, and we have to segment that into parts to really understand whether we have a problem or not.

How long could loan terms get? In Canada, we’re seeing 96- and 108-month terms.

Term is one of the several variables that dealers and lenders will use to fuel financing transactions, which in turn fuels automotive retailing growth. If a superprime credit customer wanted a 96-month term, that doesn’t mean that Armageddon is just around the corner. We have to look at the collateral, the value of that loan and the credit quality of the client or the applicant and then consider the term before drawing any conclusions.

How do monthly payments drive loan term?

It is this payment capability from the lending community that is fueling automotive retailing growth. A high percentage of cars are financed for all of us, for obvious reasons. The industry, I think, is responding quite well and, I believe, quite responsibly by giving customers what they want but doing so in a way that doesn’t create huge, terrible lending practices or significant portfolio risk. There’s no doubt if you ask a customer to sort of rank the most important factors when they’re looking at a car, ultimately you’re going to find payment in the top one or two.

You can reach Hannah Lutz at hlutz@crain.com -- Follow Hannah on Twitter: @hm_lutz

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