1 in 4
Nearly 1 in 4 consumers who financed a new vehicle purchase with a trade-in were underwater on their prior car loan.
$6,255
The average amount owed on upside-down loans climbed to a record high of $6,255 in Q2 2024, compared to $4,487 in Q2 2022.
Source: Edmunds, July 2024
HIGH VEHICLE PRICES
Vehicles are more expensive than ever and interest rates are high. To help consumers get a more affordable monthly payment, financial institutions are extending terms from 48 to 60 months up to 84 and 96 months in some cases.
EXTENDING TERMS
Longer terms do lower the payment but unfortunately extending terms can trigger and exacerbate the negative equity challenge. Borrowers will often go upside down on a loan and into negative equity at 48 to 72 months primarily due to depreciation.
ROLLING OVER NEGATIVE EQUITY
If they roll over their negative equity into another loan with an extended term, it is likely they will find themselves on the negative equity treadmill just a few years down the line. Consumers are indeed reaching up to 125% to 150% of LTV, which creates a serious negative equity cycle.
FINANCIAL HEALTH?
Negative equity has implications for both the borrower and lender that make it compelling to help members and customers with alternatives. If we want to focus on loan growth as financial institutions, we need financially healthy buyers.
What alternatives do lenders have to avoid the increased risk of negative equity for their borrowers?
1
Stepping off the treadmill with a residual-based, walk-away balloon loan.
Borrowers need a reliable vehicle. If they are at 130% LTV, they could finance their purchase with a balloon loan that includes a walk-away option. For example, let’s say they finance a $50,000 vehicle at 130% LTV, which is $65,000. The lender deducts the guaranteed residual value from the $65,000 to calculate the vehicle monthly payment, resulting in a lower, more affordable monthly payment. At the end of the term, the consumer elects to turn the vehicle in and walk away. The borrowers are now out of the negative equity cycle while being able to drive a newer, more reliable, family-sized car.
2
Recapture programs
Recapture programs help financial institutions by providing offers that attract borrowers back to the them to refinance their vehicle and lower payments on a conventional loan, or to put them into a residual-based loan like a balloon or lease. Not everyone qualifies, but this approach can effectively help members lower monthly payments and break the cycle.
3
Workout loans
If borrowers go into default, it’s not good for anyone. As an alternative to turning in the keys and defaulting on the loan because their payment is too high, the borrower could refinance, if they qualify, into a residual-based loan like a balloon or a lease. The result is a more affordable payment and the consumer keeps the vehicle and gets on a path to breaking the default cycle.