Customers favor long loan terms to keep their monthly payments low, but the decrease in the duration of the loan can be explained by increased refinancing and more consumers with positive equity in their vehicles, Jason Laky, TransUnion’s senior vice president and automotive business leader, told Automotive News.
Auto loan refinancing activity has grown with low interest rates and an increase in lenders entering the refinance business, Laky said. And “because used-vehicle prices have been relatively strong and steady for the past few years, many consumers have been able to pay their loan principal down sufficiently so that their trade-in covers the outstanding balance,” Laky said.
For lenders, shorter-than-expected loan durations affect their profitability. They receive one less payment than anticipated, Laky said. On the other hand, the decrease in loan duration could be a good thing for dealers if consumers are trading in vehicles more frequently.
The study also warned that the longer the duration in loan terms, the higher the delinquency rates, no matter the borrowers’ credit tier.
It’s an important finding, Laky said, because it confirms what lenders would expect: “When you lend money longer,” he said, “there’s more opportunity for consumers to become delinquent.”
The 60-day delinquency rate for superprime borrowers doubled to 1.8 percent for 73 to 84 month loans, compared with 0.9 percent for 61 to 72 month loans.
“Lenders that can lend an extended term and manage the risk of delinquency rates can justify making those loans because they can do it profitably, and it’s what the consumer wants,” Laky said.
Healthy loan performance starts with effective underwriting and origination practices, he said. After that, lenders should take advantage of available tools for managing “down-the-road delinquency” and routinely review consumers’ credit health to detect the warning signs that a borrower is struggling to pay, Laky said.
“Nobody wants the consumer to have trouble with their loan,” he said. And “the dealer wants a happy consumer coming back to the dealership for their next car.”
There’s a metric to determining whether or not a long-term loan customer will be delinquent.
The study found that the risk from longer-term loans lessened when consumers had sufficient cash flow for a new auto loan. TransUnion used its CreditVision aggregate excess payment, or AEP, algorithm, a screening tool that incorporates monthly payments from mortgages, credit cards, student loans and other debt payments to determine the customer’s ability to afford a new auto loan. Across all credit segments, borrowers with a positive excess payment -- that is, money left over after their minimum payments were made -- performed better, and consumers with negative excess payment were more likely to be delinquent.