Falling used-vehicle prices fuel the growth in negative equity

Falling used-vehicle prices are exacerbating the growing problem of negative equity on trade-ins, experts say. And it's not going to get better anytime soon.

Negative-equity rates are on the rise, driven in part by what was until recently strong growth in subprime loans and lengthening loan terms, according to Black Book analyst Anil Goyal.

Goyal said that while lenders are beginning to cut back on subprime financing, negative-equity rates will continue to rise as used-vehicle prices tumble. Customers who years ago had banked on their vehicle being worth a high amount at the end of their loan are instead entering an unfavorable market for sellers, he said.

"Customers are either having to come up with, say, an extra $2,000, or often the remaining value of the loan gets rolled over into another loan," Goyal said. "It's essentially increasing the price of the vehicle you're getting, which in turn increases the loan-to-value ratio even more. It sort of feeds on itself, and it's getting worse."

Used-vehicle prices, impacted by a glut of off-lease vehicles returning to the market and high new-vehicle incentives, particularly for cars, are falling. The drop follows years of growth, making it more difficult for someone seeking to trade in their vehicle to ensure they are above water.

"The majority of car transactions involve a customer who already has a car and wants to trade up to another. It's what drives the industry," and rising negative equity can disrupt that, Goyal said.

He said two things need to happen to ease the negative-equity situation: Banks need to cut back on subprime lending, and used-vehicle prices need to stabilize.

Used-vehicle prices likely will face negative pressure for the next few years as off-lease cars and trucks come back to the market at a record pace. Banks, however, are beginning to cut back on subprime lending as losses grow, although credit availability for riskier buyers still appears to be somewhat favorable, said Tom Webb, chief economist at Cox Automotive. "In essence, that's just kicking the can down the road," he said.

It's not all bad news for the industry on negative equity, though. Goyal said rising negative equity could help balance the used-vehicle market's supply problem in the long run.

"The bright side of it is that it kind of helps in balancing some of the supply, which will continue to come in from lease returns," he said. "The supply will get limited as you have fewer customers being able to take out a loan."

Hannah Lutz contributed to this report.