Will the auto bubble burst?

By Nicky Sullivan

The American love affair with the car is well documented, but this cherished relationship may well be running out of gas as more Americans than ever are at least three months behind on their auto-loan repayments.

The lesson is that even if you’re approved for a loan, it doesn’t mean you should take it (at least at the value offered).

Ever since Henry Ford decided he would build a motorcar so low in price that “no man making a good salary will be unable to own one”, modern America has been designed in such a way that that few workers on any salary can afford not to own one.

For many, the car is more than just an essential means of transport; it also represents a potential refuge in case the worst happens and they lose their home. This is why auto loan repayments are typically tended to ahead of other loans such as credit cards and student loans, and why delinquencies raise the pitch on the alarm.

At a time when record car sales are seeing more auto loans being created than ever before, it is worrying that more than seven million people were 90 days or more behind on their payments at the end of 2018. That is over one million more people in trouble than during the last loan-delinquency peak in 2010, although the overall proportion of loans in arrears remains below the levels reached in that period.

According to the Federal Reserve, this substantial and growing number of distressed borrowers suggests that not all Americans are benefitting from the current strong labour market. The worst affected are borrowers under 30, whose delinquency rates made a dizzying jump between 2014 and 2016 before more or less stabilising. Meanwhile, older age groups have been slowly but steadily creeping up the chart since 2012.

Not only are Americans buying more cars, they’re also borrowing more to pay for them. The average amount outstanding on an auto loan increased from $9,687 in 2013 to $11,102 last year. This includes all types of outstanding auto loans; not just those 90-plus days delinquent.

Donald Trump’s one-off tax giveaway can take some of the credit for the latest surge in car sales, but record low interest rates are behind the explosion of total outstanding auto loans from $655 billion in 2010 to $1.1 trillion by November 2018. The problem with interest rates however, even ones that have remained historically low for a long period of time, is that they can go up, which is exactly what happened several times last year.

But the risks don’t only extend to American workers. When alarming numbers of car owners find themselves unable to pay off their loans, the companies who loaned them the money can find themselves in the firing line too. In a blog posted by the Federal Reserve, the authors identified those companies as finance companies who are likely servicing the subprime market, rather than car dealerships or banks.

Subprime auto lending accounts for 50% of auto loans on finance company books, and 25% of loans on large banks’ books.

But while the question of whether there is an auto bubble that might be close to bursting is unanswerable for now, the key question for borrowers is what steps do they need to take to keep their car on the road.

It’s important to remember that just because a lender approves you for a loan it doesn’t mean that you should take it, especially as more interest rate rises are predicted for this year. Read the terms and conditions carefully to understand fully what can happen with your payments if interest rates do rise.

If you can’t afford to pay that rate today, don’t take the loan.

When financing a new (or pre-loved!) automobile, it’s important to question the amount you need to borrow. Do you really need the one you’re thinking of, or could you find a vehicle that offers better value? It’s not sexy, but neither is cutting out meals so that debts can be paid.

Finally, and in an ideal world, budget at least six months of savings that will cover living expenses before taking out a loan.