Credit availability and new and used vehicle sales are basically joined at the hip. After all, automaker captive finance companies were created with the mission to provide credit to consumers so more new vehicles could be bought and produced. Among many things, the Great Recession and the years since reaffirmed the lesson that as credit availability goes, so go new and used sales. Prices are also affected by access to lender cash. The incredible interest rate wave the market has been riding for the past few years combined with ever-increasing loan terms have allowed consumers to buy more richly contented vehicles with only nominal changes in monthly payments.

For example, Experian Automotive data show the average amount financed for new and used vehicles grew by 10% ($2,592) and 8% ($1,419), respectively, from the fourth quarter of 2010 through the Q4 2014. How much did monthly payments rise over the period you ask?  Just $18 for new loans and $8 for used ones ― essentially the price of two or three Starbucks Triple Grande cappuccinos per month.

But while the credit climate has been exceptional for some time now, history tells us that it won’t stay that way forever. In fact, some have postulated increasing subprime share of auto loan balances is forming a nascent auto credit bubble. While current trends effectively debunk this viewpoint, certain data points do point to more challenging credit conditions in the future.

Here’s a brief summary of the current state of auto credit along with some comments regarding future implications:

  • According to the Federal Reserve’s most recent report on U.S. household debt, outstanding auto loan debt reached $955 billion in Q4 2014, up 11% from the same quarter in 2013 and 15% more than the pre-recession high set back in Q3 2005.
  • But while auto loan debt is up, the rise pales in comparison to student loan debt. Fed data shows student loan debt reached $1.15 trillion in the fourth quarter last year, up 7% from Q4 2013 and a whopping 111% higher than 2007’s fourth quarter figure of $548 billion.

Student loan debt exceeded auto debt by 21% at the end of 2014 and the ongoing increase in college loan balances could play a role in dictating demand for new and used autos in the future.

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The bulk of following information was derived from Experian Automotive’s quarterly “State of the Automotive Finance Market” reports.

  • Experian Automotive data reveals that the below prime (deep subprime to nonprime) share of originated new and used auto loans stood at 28.2% and 54.9%, respectively in Q4 2014. The quarter’s below prime share for used originations was down more than a half point from Q3 2013, while new origination share was up more than a point. Although below prime originations have been trending upward, share remains well below pre-recession highs.
  • Experian data also shows that both 30 and 60 day delinquencies were essentially flat on a Q4-to-Q4 basis. Per Fed data, the share of balances seriously delinquent (90+ days) did tick up in the fourth quarter last year (0.12 points to 3.16%), however, the overall trend is a downward one. Comparatively, student loan delinquencies have taken off over the past decade; 11.3% of student loan debt was seriously delinquent last quarter, nearly two times the 6% rate averaged over the first half of the last decade.

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  • Returning to Experian data, the percentage of new and used auto sales financed reached 84% and 55%, respectively in Q4 2014, up nearly 10-percentage points from Q4 2009. The fact that more vehicle sales are carrying loans not only adds to total outstanding auto debt, it also exposes lenders to increased risk when borrowers default.
  • The share of new and used auto loans exceeding a 60 month term reached 66% and 55%, respectively, in Q4 2014, figures equating to 11 and 10 point increases from Q4 2011. More than a quarter (26%) of new loans carried a term above 72 months, while 15% of used loans were similarly booked. Stretched loan terms and low interest rates may allow consumers to buy more richly contented autos, however, longer terms and higher rates―not to mention faster depreciation (which we expect)―will increase the time it takes for borrowers to reach a positive equity position. This of course will delay the time it takes shoppers to return to the market, and/or lead to more negative equity being rolled into new loans.

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To summarize, current auto finance conditions remain on stable ground. The below prime share of originations is reasonable, delinquencies are still low and lenders and consumers are eager to do business with one another.

There are negatives, though. While rates remain near historic lows today, they will be on the rise―albeit at a slow pace―before too much longer. As mentioned earlier, higher rates along with faster depreciation and longer loan terms will negatively affect equity position. In addition, the rise in outstanding debt, buoyed in part by the growing number of vehicles financed, means lenders have more skin in the game than they did a few years ago. This places more cash at risk should borrowers default. 

Less understood is how the worrisome rise in student loan debt will affect new and used vehicle sales. Will consumers saddled with college debt be forced to buy more inexpensive new vehicles, or will they gravitate toward pre-owned ones? While we’ll probably have to wait and see how this one plays out, we can say with greater confidence that college debt, which is now second in size to mortgage debt, will have an impact on spending.

All in all, a favorable credit environment should continue to help fuel auto sales for some time to come; however, it would probably be wise for lenders to pay keen attention to collateral risk and portfolio performance today to mitigate future liability. As time management guru Alan Lakein once said, “Planning is bringing the future into the present so that you can do something about it now.”