Why a large U.S. auto lender isn’t concerned about ‘forever loans’

The head of one of the nation’s largest auto finance lenders isn’t particularly concerned about rising consumer auto debt and the fact that inflated used car prices are leading to longer loans on vehicle purchases.

His main logic? The percentage of income consumers spent on their vehicles remained relatively flat compared to 2019, before the coronavirus pandemic led to inflated prices as demand rose but inventories remained low.

“If I said to you, ‘Car prices are going up, interest rates are going up, insurance prices are going up,’ you would say, ‘You know, consumers should be paying more relative to income.'” Capital One Automotive President Sanjiv Yajnik told CNBC. “But if you look at each quintile of people’s wages and earnings, the pay-to-income ratio remains fairly constant.”

While Capital One reports that average monthly vehicle ownership payments have increased from $390 to $525 since 2019, data from its auto unit provided exclusively to CNBC shows vehicle costs have remained relatively flat compared to income. That’s because overall the payout-to-revenue ratio has remained stable at around 10% since 2019, according to the American bank’s automotive arm.

Capital One Auto found that 80% of car buyers who finance a vehicle are below the generally accepted 15% pay-on-income threshold.

Referring to consumers who prioritize vehicle payments for transportation, including work, Yajnik said, “The consumer is being cautious. He is being responsible. This is a much healthier way than the alternative because it is not an optional expenditure.”

But to achieve that goal, more consumers are taking out longer loans to keep payments affordable.

The opinion of one veteran of auto finance contrasts with others in the industry who see long-term loans as a detriment to consumers’ pockets.

They argue that so-called “forever loans” of six years or more have led many buyers, especially new vehicle buyers, to have the equity in their cars and trucks underwater. This means that when they decide to trade in the vehicle, they owe more than their vehicle is worth.

Edmunds reports that roughly 26% of used vehicles purchased that include a trade-in vehicle had negative equity through April this year. The amount of negative equity averaged $5,105, an increase of 35% compared to 2019.

“As loan term lengths increase on average, the pace at which consumers make progress paying off their balances slows,” said Jessica Caldwell, president of Insights. CarMaxEdmunds wrote: in a recent online publication. “If consumers trade in their vehicles too soon for any reason, they end up with more and more loan debt.”

Regarding new vehicle financing in the first quarter, 90.2% of new vehicle loans with negative equity trade-ins had a term of at least 72 months, with 43% extended to 84 months, according to Caldwell. The average negative equity trade for new vehicles during the quarter was $7,183, according to Edmunds.

These figures have been rising since 2022, when inflated used vehicle values ​​caused by the chip shortage triggered by the pandemic saved more customers from carrying debt on their next vehicle.

According to Yajnik, consumers need to keep their vehicles for a longer period of time to be able to reap the benefits of long loans. However, this can also result in increased maintenance costs and the possibility of the vehicle needing repairs that exceed its value or being scrapped altogether.

“Yes, it takes longer to get your equity, but in the meantime you’re driving the car and making money,” said Yajnik, a 28-year Capital One veteran who has led its automotive lending division since 2008.

The average list price of a used vehicle was $25,390 in March, according to Cox’s most recent data. This compares to $48,667 compared to new vehicles that depreciate faster.

Cox Automotive reports that, all else being equal on a loan, financing a $30,000 vehicle at 9 percent annual rate would be $3,100 more expensive over an 84-month term than a 48-month loan. But there’s a difference of $264 in monthly payments, which Yajnik says makes it more affordable for many consumers, especially those in lower income brackets.

“Of course there will be segments of people who have problems, but it is necessary to start from a different place, namely, for what reason do people buy cars and are they doing so irrationally?” Yajnik said.