Affordability has been the topic of conversation across the automotive industry over the past several years, and with COVID-19, the spotlight is even brighter, particularly as average loan amounts continue to grow.
To find ways to stay within budget, many consumers were swayed by manufacturer incentives, while others have stretched their loan terms to make their monthly payments manageable. In fact, the average new vehicle loan term reached 71.54 months in Q2 2020, up from 67.97 months during the same quarter just five years ago. On the surface, some are concerned about the extension of loan terms, as it can make vehicles more expensive in the long run or cause financial hardship for consumers, but that may not necessarily be the case.
Prime consumers seek longer term new loans
While the average loan term for a new vehicle is almost six years, not every consumer is choosing long term financing. The consumers with the highest increase in loan terms fell into low-risk categories. For instance, super prime consumers showed the largest increase of 3.71 months compared to last year, while prime consumers increased their loan terms by 2.57 months in the same time frame.
In addition, the longest loans—those with 85-96-month terms—belonged to consumers with an average credit score of 720 in Q2 2020, up from 703 one year ago. Some industry pundits believe longer term loans open consumers up to potential default, but the fact that low-risk consumers account for the most significant increases in terms, should quell some of the concern.
Longer Terms Keep Monthly Payments Down
The extension of loan terms coincides with significant increases in the average loan amount for a new vehicle—which increased nearly $4,000 in Q2 2020. Much of that increase has been driven by consumer preferences as full-sized pickups became the most financed new vehicle.
Even with an increase in loan amounts, when combined with extended terms, monthly payments for new loans have only increased slightly and have remained relatively on par with last year. The average monthly payment increased $18 year-over-year, with the average monthly payment coming in at $568.
To understand the impact that extended loan terms can have on the monthly payment, let’s take the average loan amount for a new vehicle ($36,072) and the average interest rate (5.15%). With 60-month terms, the monthly payment would be approximately $683, while with 72-month terms, the monthly payment would cost about $583.
So, while there is an increase in new loan amounts, consumers are finding ways to manage their payments, and longer loan terms have played a significant role in that.
Making Financing a Vehicle More Affordable
Another contributing factor that minimizes the likelihood of default with longer loans is lower interest rates. The average interest rate for a new vehicle is 5.15% as of Q2 2020, down from 6.25% in Q2 2019. That means, choosing a longer-term loan won’t have the same impact as previous years. As consumers’ financial situations will likely remain dynamic in the coming months, lenders should work with consumers to ensure that their loan options fit their needs, to make vehicle purchases more enticing and help them stay within budget.
Consumers are taking advantage of new car incentives, low interest rates and longer-term loans in order to ensure that their vehicle purchase is manageable. But, with the long-term effects of COVID-19 still unknown, it’s important for lenders to ensure they’re helping consumers make the best possible decisions. Understanding trends in the auto finance market can better position lenders and dealers to provide the best, most affordable options for each consumer.
To view the full Q2 2020 State of the Automotive Finance Market report, click here.