When Jennifer and Bobby Post traded in their 2001 Chevy Suburban last year for a shiny new Ford F-350 turbo diesel with an extended cab, it seemed like a great deal. Even though they still owed $9,500 on their SUV after the trade-in value, they didn't have to put a penny down.
The dealership, near the Posts' home in Victorville, made it easy; it just added the old debt to the price of the new truck and gave the couple a seven-year, $44,276 loan.
The Posts were a little worried about taking on such a long obligation, but they couldn't pass up a monthly payment under $700. Now they're having regrets.
"I didn't realize how much debt was in it," said Jennifer Post, who has since moved with her family to Iowa. Now, she'd like to get rid of the truck but can't, because there's so much debt that she'd literally have to pay someone to take it off her hands.
"We have no options," she said.
Americans haven't just been taking out risky mortgages for homes in the last few years; they've also been signing larger automobile loans for significantly longer terms than they used to.
As a result, people are slipping into a perpetual cycle of automobile debt that experts think could lead to a new credit crunch extending from dealerships to driveways and all the way to Wall Street.
Gone are the days of the three-year car loan. The length of the average automobile loan hit five years, four months in October, up more than six months from 2002, according to the Federal Reserve. And nearly 45% of loans written today are for longer than six years. Even some staid lenders owned by the carmakers, such as Toyota Financial Services and Ford Credit, are offering seven-year financing. And a few credit unions, particularly in the West, are tinkering with the eight-year note.
At the same time, the amount of money drivers owe on their cars is soaring. In October, the average amount financed hit $30,738, up $3,500 in just a year and nearly 40% in the last decade, according to the Fed. More troubling, today's average car owner owes $4,221 more than the vehicle is worth at the time it's sold -- up from $3,529 in 2002, according to industry analyst Edmunds.
The longer loans are directly related to the higher balances. By extending the length of loans, lenders keep monthly payments down. But because these loans take longer to pay off, a much larger piece of the principal remains unpaid at the time the car is traded in.
The response of the automotive finance industry? Extend loans further and allow the indebted customer to roll what he owes into a new loan with little, if any, effect on his new monthly payment. In effect, the driver is paying a loan on two -- or more -- cars at once.
Richard Apicella, head of Benchmark International's auto finance division, published a report on car loans last month that called the ever-lengthening deals a "dangerous" problem. Combined with Americans' desire to drive new cars every few years, he said, the effect "is like a drug. Once you get hooked on it, it gets harder and harder to break the cycle."
From the point of view of those who sell cars and car loans, long-term loans are good for business and good for buyers.
"The job of a successful dealer is to find a funding package that's acceptable to the customer," said Paul Taylor, chief economist of the National Automobile Dealers Assn. "These loans allow them to get a luxury car rather than a more modestly priced vehicle."
Cindy Gerhardt has rolled over so much debt on successive vehicle purchases -- five in three years -- that she now owes almost $43,000 on two trucks worth no more than $29,000 and, she says, perhaps as little as $22,000.
Faced with car payments that exceed her monthly mortgage, she tried to trade in the pair for a single vehicle. But with so much unpaid principal on the vehicle loans, the only offer she got from the dealer was to trade in one truck on yet another new vehicle -- and increase her debt by another $25,000.
"It's our own fault that we traded in vehicles so many times, but we never thought it would get to this," said Gerhardt, a secretary who lives with her husband and two children in Clinton, Okla. She recently tried to refinance her mortgage, she said, but was declined because her car payments were too high. "Not one dealer ever said this was a problem. Ever. I never had a dealership say no."
It's not just individual consumers who are at financial risk. Nationwide, an estimated $575 billion in new and used auto loans are written every year by auto manufacturers, banks, credit unions and other lenders. About 30% of the loans that are originated by banks, and 100% of those issued by automaker financiers, are, like mortgages, repackaged and sold as securities, according to the Consumer Bankers Assn.
Analysts warn that just as investors didn't comprehend the risk inherent in some of the more exotic home mortgages in recent years, they aren't considering how risky these car loans are. If longer loan terms allow debt on the loans to grow too large, many drivers may simply default, leading to expensive repossessions.
And even those who keep paying their bills may reach a point, like Gerhardt, where they simply can't afford another car. That could send vehicle sales down the drain, a nightmare scenario for an industry that has already taken a hit this year from slower consumer spending and higher gas prices.
It could also lead to serious losses among financial institutions that have invested in car debt. Among securitized auto loans, two-thirds have terms longer than 60 months, a fact that Standard & Poor's, which rates auto debt for sale on the secondary market, calls a "credit concern."
This month, S&P; reviewed its ratings on $113.5 billion in auto loan securities it rated in the last two years out of concerns over growing losses. It didn't make any downgrades but predicted that "rising losses will continue into 2008 across all segments of the auto loan market."
S&P; has found that delinquencies of more than 60 days on car loans issued this year to borrowers with the best credit are up 20% compared to those issued last year, while delinquencies on loans issued this year to subprime borrowers increased by 16%. Delinquency rates on car loans are still far lower than on mortgages, but there is growing concern in the financial services industry. Indeed, Tom Webb, chief economist of used-auto analyst Manheim Consulting, said he expects the tally for 2007 repossessions to be up by 10%.
Mark Pregmon, executive vice president for consumer lending at SunTrust Bank, is among the concerned. "Any time you extend the maturity of the loan, you take on more risk. The question is whether there's enough assessment of that extra risk," he said. "Obviously, it's a problem. It's a house of cards."
In the 1970s and '80s, car loans hovered between 36 and 48 months, and drivers typically kept their cars longer than the life of the loan. A number of factors changed that.
One key was interest rates, which fell from a high of 17.8% in the early 1980s to lower than 5% today, according to the Federal Reserve. Another was affordability. According to an index tracked by Comerica Bank, cars have steadily gotten more affordable -- as compared to median family income -- since the late 1990s.
With cheap money at hand for more-affordable cars, the temptation to keep buying became huge. Today, according to Pregmon, financed cars are typically turned over in 24 to 36 months.
At the same time they were extending loan maturities, lenders, competing with one another, began offering more money and requiring smaller down payments.
Today, most lenders offer financing on 100% or even 125% of the sticker price, and some offer the most credit-worthy buyers loans for twice the value of the vehicle they're purchasing. Last year, the average amount financed for new cars reached 99%, according to the Consumer Bankers Assn., up from 95% in 2005.
Lenders are beginning to brace themselves; many have said they intend to tighten standards and require larger down payments.
Despite warnings from S&P;, the Consumer Bankers Assn., Lehman Bros. and others, there is little sign that the automobile industry is willing -- or, with consumers demanding low payments, even able -- to reduce the lengths of the loans they issue.
"For banks, it's a matter of meeting consumer demand: no money down and extend the term," said SunTrust's Pregmon. "But as a lender, you've got a moral obligation as well. Are we putting the clients in loans they can't afford?"