Lenders differ on 84-month loans

Doomsayers are bemoaning a spike in seven-year car loans, predicting dire consequences for lenders and the national economy from trapping consumers in auto debt for so long. A recent Wall Street Journal article gave added prominence to those fears.

But while 84-month loans have risen from a small base in the aggregate, they are not climbing at all lenders across the industry. Instead, the uptick in 84-month loans seems to stem from a few confident auto financing players intent on increasing market share. Auto lenders' views on those loans — and the volume they hold in their portfolios — vary greatly depending on risk appetites, underwriting practices and alternative data policies.

Lenders who support, or at least tolerate, longer loans believe that improvements in underwriting metrics and the use of alternative data makes calculating the risk of these loans easier now than ever before. Those who avoid 84-month loans say they are bad for consumers.

Those opposed to longer loans note that a lot can happen in 84 months. Tyson Jominy, for example, had three children in that timeframe.

If he had been a car buyer at the start of that stretch, his vehicle needs would have been "radically different" from those at the end, said Jominy, vice president of data and analytics for J.D. Power. "I could get away with a two-door Jeep in the beginning" but by the end needed a minivan, he said. "If I have to wait for equity to build" to finance a new vehicle to meet those new needs, "that's a challenge."

Jominy said many consumers aren't considering the implications of an 84-month loan when they sign one — only the monthly payment it affords. Seven years is "longer than some people's marriages," he said.

Yet affordability concerns continue to stretch car buyers, with little recourse outside of tacking months on to the loan. As transaction prices reach all-time highs, term lengths are often the only lever left for consumers to pull to drop monthly car costs.

In the third quarter, 84-month loans represented 7.1 percent of the 3.6 million cars financed in the U.S., J.D. Power data shows, up from 4.2 percent in the third quarter of 2015.

Loan terms over 85 months accounted for 1.3 percent of new-vehicle loans in the U.S. in the third quarter, data from credit bureau Experian shows, up from 1.1 percent a year earlier. Used-vehicle loans with terms between 73 and 84 months also rose, to 19 percent from 18.1 percent.

The average new-car payment in November was $586, up $76 from 2014, according to car-shopping site Edmunds, with an average transaction price of $37,981.

Driving up costs is consumer demand for larger, more expensive vehicles and additional content and safety features in new vehicles. Jominy says these features mean payments are unlikely to revert to the lower levels seen in previous years.

"It keeps getting uglier and uglier the further we go. Longer cycles, longer timed equity, more people out of the market with their cars. It's a very challenging time for the industry," Jominy said.

A September report by S&P Global Ratings outlined the risks of 84-month car loans. Vehicle depreciation over the life of a longer car loan could increase the odds that a customer is "upside down" on the loan, meaning they owe more money to the bank than the car is worth.

Longer terms also drag out the time before a customer builds equity in the vehicle, which increases the odds they might stop paying off the vehicle if faced with a financial hardship.

Risk of default on longer loans also mounts if they are issued to customers who have low credit scores or have higher payment-to-income ratios or higher loan-to-value ratios.

But Ally Financial CFO Jenn LaClair says consistent underwriting has been a staple of auto lending for the past several years. Citing industry data, she said industrywide underwriting has tightened in 13 of the last 14 quarters.

"It appears that people are trying to grab headlines on some fringe segments and maybe some pockets of the population, but I don't think [the increase in 84-month loans] is reflective of the industry at large," LaClair told Automotive News. "It's certainly not reflective of Ally."

Ally's terms average within a 70- to 71-month range, LaClair said. Used-vehicle loans make up about 50 percent of Ally's auto portfolio.

Kyle Birch, COO of North America at GM Financial, doesn't prefer 84-month loans but accepts that they're a growing part of the captive's auto portfolio.

"We don't shy away from it. But as a captive finance company, we would like to do shorter-term loans so that as the customer moves through the life cycle of that loan, they have a quicker touchpoint back with the dealer to maybe buy a new vehicle," Birch said at the Auto Finance Summit in October.

On the other hand, Birch said, if it takes an 84-month loan to make the sale, that also could help retain a service customer for the next seven years.

Most customers enter dealerships with a vehicle type and monthly payment in mind, Birch said. Longer terms allow dealers to balance those expectations and still have room to sell ancillary finance and insurance products.

Bill Himpler, CEO of the American Financial Services Association, said loan terms gives consumers options in the new-vehicle market they wouldn't otherwise have.

"Each consumer's financial situation is unique and having the option to get into a new, more reliable vehicle is a net positive," he said in a statement.

"When working with a creditor on a responsible consumer credit transaction, consumers should have a number of choices based on their ability to comfortably cover their loan payment."

Lenders want to grow auto portfolios, but without increasing the risk of default.

Birch said lenders wouldn't originate 84-month loans if they weren't confident in the consumer's ability to pay them back.

Mark O'Donovan, CEO of Chase Auto, says 84-month loans make up a low single-digit percentage of the lender's business, and that Chase has a strict policy for originating them.

"When we write loans that are of longer term, we actually ensure customers can qualify for a lower term," O'Donovan said.

Chase manages an $83.1 billion auto portfolio as of the third quarter of 2019, fueled by a roster of private-label, captive-like partnerships with Subaru, Mazda, Jaguar Land Rover, Maserati and Aston Martin. Chase also has a similar agreement with Enterprise Car Sales.

Affordability is still a concern worth watching, but O'Donovan added that most conversations of stretching loan terms neglect to mention how vehicle values have also extended over time.

"Cars are lasting a lot longer than they used to," he said, prompting the question, "Is 72-month the new 60-month?"

Rich Porrello, president of auto finance at Huntington Bank, says analysts focused on loan terms alone are neglecting other key factors of those auto deals, such as the loan-to-value and debt-to-income ratios. Huntington has an indirect auto lending portfolio of just over $12 billion.

"That's the fallacy in the industry. When people look and say, 'Well, there's too much 84-month' — well, what is it made up of? Which is, I think, really important," he said.

Certain lenders won't originate seven-year car loans.

Longer-term loans aren't common at Wells Fargo. Used vehicles make up about 70 percent of its auto portfolio. Laura Schupbach, head of Wells Fargo Auto, said she doesn't know whether Wells Fargo has originated even half a dozen 84-month loans all year. The company's auto portfolio was $46.7 billion as of the third quarter.

"We don't think it's good for the consumer. We think if someone is stretching that far, it's probably not enough in keeping with what we want to do, which is to help our customers succeed financially," she said. "Especially for a used car, an 84-month term would be extremely long."

Charles Bradley, CEO of Consumer Portfolio Services, a subprime auto lender, said the lender wouldn't go near an 84-month loan and would even balk at a 72-month term.

"But you do see the folks doing it," Bradley said. "In our world, people have bad credit. What we're seeing much more on our side of things is lenders really kind of really extending out, putting a person in a car who probably should not be in that car. And they're doing it anyway because they want the growth."