More cars are finally available and prices are leveling off, but buyers now face borrowing challenges that could keep them from getting a new ride.
The Federal Reserve said the rejection rate for auto loans in June rose to 14.2% from 9.1% in February, the last time the survey was taken. That was the highest level since this data was first collected in 2013 and for the first time, exceeded the application rate.
Lenders are pulling back, leery of borrowers who have struggled with high inflation and a surge in interest rates the last couple of years, and have piled on debt to make ends meet. As consumers’ credit balances grow, there’s a higher chance of default, especially in the market for auto financing, where the number of Americans paying at least $1,000 a month on new loans reached a record high of just over 17% in the three months ended June, according to Edmunds, the online car resource and information company.
With giant payments like that, it’s not surprising auto loan performance has been deteriorating. A severe delinquency rate in May was the worst since at least 2006 when data was first collected, while the default rate rose to nearly what it was in 2019, according to Cox Automotive, which provides tools for car buyers, sellers and owners. Severely delinquent loans are more than 60 days past due and defaults are more than 90 days past due.
“Consumers who are paying large amounts of finance charges could be in jeopardy of falling into a negative equity trap,” said Ivan Drury, Edmunds’ director of insights. Negative equity is when the amount owed on a vehicle exceeds the value of the vehicle.
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Will it get worse for consumers?
Many lenders, including Fifth Third Bancorp, Citizens Financial, U.S. Bank and Capital One Financial, have already either cut out or scaled back auto lending.
“Consumers are already under pressure, and they’re even worse off because banks are reducing their lending,” said Alex Liegl, chief executive at electric vehicle financing company Tenet. “If there are fewer options, interest rates are going to further increase for customers. Typically, sometimes, they won’t even qualify for financing, so they’re shut out from getting the car they want.”
The Fed said the average reported probability that an auto loan application will be rejected increased sharply to 30.7%, the highest level since the Fed started collecting this data in 2013.
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What can consumers do?
If you’re looking for an EV that qualifies for a tax credit, Tenet offers financing that will allow you to maximize your credit from the day you purchase instead of waiting to claim it on your tax form.
If your EV costs $50,000 and qualifies for a $7,500 tax credit, your loan amount would be reduced by $7,500 to $42,500, which would cut your monthly loan payment. When you receive your tax credit in 12 months, you can pay back the $7,500 without interest on it or pay it as part of your loan.
“It gives people more flexibility to leverage tax credit,” Liegl said. Sixty-five percent of Tenet’s customers do this to reduce their principal on day one, and 12 months later pay it off, he said.
As a more general tip, “it’s critical to come to the table with a comprehensive budget and a feel for the financing elements of a car purchase beyond the monthly payment, including the APR,” Drury said.
Though many people will extend the term of the loan to lower their monthly payments, experts advise against that because the longer the duration of payments, the more you end up paying in interest. It’s better to make a larger downpayment or buy a less fancy car, Drury said.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her atmjlee@usatoday.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday.