When an 84-month loan makes sense

UPDATED: 6/15/16 3:24 pm ET - adds details

Auto loans lasting seven years or longer have created a stir within the industry, with some lenders testing extended terms and others keeping a distance.

But Equifax data show that, in some cases, the longest loan terms are less risky than shorter terms.

From November 2013 to October 2015, among borrowers with credit scores of 641-680, loans of 84 months or longer, when compared with other term lengths, had the lowest average 30-day delinquency rate at 1.56 percent. Loans lasting 72 to 77 months had the highest average 30-day delinquency rate at 2.87 percent.

“As an industry, overall, lenders are doing a very good job extending terms for the right customers,” Equifax auto finance leader Lou Loquasto said during a Consumer Bankers Association presentation last month. “A lot of times when lenders ask us to evaluate a segment they’re not in, extended terms is one of the more popular asks that we get.”

There is at least one scenario in which an 84-month loan would make sense for consumers, Loquasto told Automotive News.

In a scenario where an 84-month loan would be fitting, a consumer, given today's low interest rates, may think: “If you’re going to give me money that cheap, I’ll take as long a term as you give me. Why should I pay $1,500 per month? I’ll just pay $600,” Loquasto said.

In another case, a consumer who wouldn’t qualify for another loan term may qualify for an 84-month term based on the payment-to-income ratio, but a shorter loan would likely make better sense. “If a consumer makes $40,000 per year and wants a $50,000 car, they can’t qualify at some terms,” Loquasto said. He recommends against raising the term to 84 months as the only way to qualify a customer.

The consumer could buy the car he or she had in mind and use the saved money to pay down other types of debt, he said.

Higher payments

Despite the stretched term, the monthly payment for 84 month loans among borrowers with scores of 641-680 was on average $506 from November 2013 to October 2015, a bit higher than the average $429 payment across all loan term periods.

“A lot of people think that the 84-month terms are just to get superlow payments, but because the loan sizes are so much larger, the payments are higher,” Loquasto said. And consumers are financing bigger cars, he added.

The long terms will keep lenders profitable, Loquasto said. “There was a cycle in the early- to mid-2000s where a consumer might not buy exactly the car they wanted and they were getting in the ‘every two years’ trade-in cycle,” he said.

Since then, times have changed. Now consumers spend more money and finance for a longer term, and the average number of months an auto loan stays open has continued to grow, Loquasto said.

“That’s a key component to profitability for lenders. That’s one I predict will continue to be really positive for the [auto finance] industry,” he said. “If the whole portfolio stayed on the books one month longer, [lenders would gain] millions of dollars in extra interest income.”

The negative side of long terms is the time it takes to reach positive equity, and a long trade cycle could be a downside for dealers.

But a two-year trade cycle is “not as necessary,” Loquasto said. “Cars are so well-built and financing is so available,” he said.

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

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