Car debts pile up as more Americans owe thousands more than cars are worth

Chris Martin knew he needed a bigger car as the birth of his fourth child approached, but he and his wife were already $14,000 underwater with their two vehicles.

So in 2020, the couple struck an unusual two-for-one deal with an Atlanta-area dealer: swapping both vehicles so they could afford a three-row Ford Explorer. Her total loan after netting negative equity, a service contract, fees and other costs rose to $66,000 at the $49,000 Explorer.

Although he’s making great strides with the guilt, he’s uncomfortable. “I don’t want to pay interest on cars I no longer have,” said Martin, a 36-year-old data engineer.

The accumulation of negative equity — or the amount debt exceeds a vehicle’s value — is making consumers scream and alarm bells ringing in the industry.

While it’s not uncommon for riders to have negative equity, some traders say more people are getting their properties up to $10,000 underwater or “upside down” with their trade-in. They buy at ever-increasing prices and shift debt from one car to another and even to a third. Loans generally have terms of up to seven years.

“As trade-in values ​​begin to cool, more and more consumers will move from positive to negative equity each month,” said Ivan Drury, director of insights at automotive market researcher Edmunds. “If U.S. car buyers don’t break their buying habits too soon, we will see the negative stock tide continue to rise.”

Even if the U.S. economy avoids recession this year, consumers are likely to struggle to pay off their auto loans, especially as the Federal Reserve plans to raise interest rates further. According to Edmunds, the average interest rate for new cars rose in January from 4.3% a year earlier to 6.9%. While car prices continue to rise, demand is strong and inventories are relatively low, Ford Motor Co., General Motors Co. and other car manufacturers make significant profits.

For the average American, a new car is increasingly out of reach. Today, about 2 in 13 people make monthly car payments of $1,000 or more. Many have no choice: they have little or no public transport and need a car to get to work, take their children to school and do their shopping.

“Because these auto loans are generally unaffordable to begin with, it means borrowers are moving closer to the financial benefit every month,” said Kathleen Engel, a law professor at Suffolk University.

The cost of new vehicles has risen 20% since the start of the pandemic, while used cars have continued to rise 37% even after the fall slowdown. Car owners briefly entered a lucrative market where they could sell some used cars for more than they paid for them. It helped that negative equity fell earlier in the pandemic.

But as more consumers use up the savings they built up during the pandemic, they’re going underwater again.

For trade-ins with negative equity, the average amount is approaching pre-pandemic levels at $5,500, according to Edmunds data. Rising prices and the proliferation of 84-month loans are worrying consumer advocates and the auto industry.

Pete Kesterson is a dealer manager in Falls Church, Virginia. On one side of his yard is the Volvo showroom and on the other side the Kia showroom. He is much more concerned about customers shopping at Kias – who rely more on financing – than Volvo buyers, who he says often pay in cash.

“It’s going to bite us,” Kesterson said, referring to negative equity, which he believes will worsen. “Now we sell the cars for so much more and we finance longer, at a much higher interest rate. Challenges await the pike.”

Negative equity has already bitten Shawna Ballou, a 45-year-old mother of five from Tacoma, Washington, who feels “trapped” in her Ford Escape. Four years ago she traded in a Chevy Malibu and bought a 6 year old Escape for about $16,000. After accounting for the negative equity on her trading, taxes, and other fees, she has more than $25,000 in financing that she will pay back in seven years.

She’s been researching her car’s life expectancy and she’s worried about going into debt for a car that won’t even drive.

“I can’t even find someone to refinance me because the car isn’t worth it,” says Ballou, who works two jobs and is trying to set up her own business.

The negative stock boom is on the radar of officials at the US Consumer Financial Protection Bureau. They are now watching closely as the safety net of selling a used car to get out of debt is disappearing.

“Consumers were less likely to be swamped in auto loans because of rising used car prices,” said Ryan Kelly, acting auto financing program manager at the CFPB. “That could change.”

Lenders have continued to extend car loan terms in response to higher car costs. Companies like Upgrade Inc., which offers automatic refinancing, are also tightening standards for who qualifies for financing — a trend they say will continue as the job market deteriorates and prices continue to rise.

“The more likely scenario is deteriorating economic conditions coupled with the prospect of a continued fall in car prices, making it more difficult for consumers to qualify for the car they want,” said Renaud Laplanche, co-founder and CEO of upgrade.

Right now, even seven-year loans are doing well, says Margaret Rowe, senior director at Fitch Group Inc., which focuses on auto financing and asset-backed securities. But if car prices remain high and lenders continue to extend loan terms and offer them to borrowers with lower credit scores, that could change, she said.

In January, auto loan delinquencies hit the highest level since 2006, according to data from Cox Automotive.

A joke for consumers is the fluctuation in the value of used cars. After an all-time high during the pandemic, values ​​fell 13% from their peak in January, but suddenly rose again in February, according to the Mannheim Used Car Value Index. If they continue to fall, anyone who bought at the top of the market will fall further into the negative equity trap.

Subprime consumers who come in with negative equity and want to buy another car are particularly at risk, said Todd Nelson, senior vice president of strategic partnerships at LightStream, part of Truist Bank.

“They continue to borrow in a way that is not very fiscally defensible,” Nelson said. “For people in this space, if they can afford it, they’re much better off staying in this vehicle.”