Automobile repossession, or the threat of repossession, is one common reason people consider bankruptcy. Most people who ultimately file for bankruptcy have struggled with debt for years before deciding to take that step. Often, a crisis such as wage garnishment, a foreclosure action, or the threat of vehicle repossession is the trigger for seeking a solution.
In most cases, the automatic stay entered in a bankruptcy case will temporarily stop motor vehicle repossession. That allows time for the borrower to explore the possibilities and to determine whether to surrender the vehicle, redeem the vehicle, reaffirm the automobile loan, or pay the loan off overtime in a Chapter 13 Bankruptcy plan.
But, the best defense against having a car or other vehicle repossessed starts long before the financial struggles begin. The decisions you make when you purchase your car significantly impact the likelihood that the loan will go into default or end in repossession. Some of the factors may be immediately obvious, but others may come as a surprise.
Automobile Loan Statistics
Defaults and Delinquency
Nationwide, automobile loan debt has reached an all-time high, and some experts are predicting that car loans will be the next version of the foreclosure crisis. As of the end of 2019, Americans were carrying an aggregate more than 1.3 trillion dollars in automobile loans. That’s up more than 300 billion dollars from 2016, and about 16 billion dollars over the previous quarter.
Both Los Angeles County and California as a whole have lower rates of automobile loan delinquency than the national average. Still, 4% of LA County auto loans are past-due, meaning that about 35,000 people in the county are behind on their car loans. 20% of local subprime motor vehicle loans are delinquent. Note that these numbers are pre-COVID numbers and are likely to rise due to the pandemic.
In 2019, the average new automobile loan amount and average monthly payment hit all-time highs. That’s generally bad news for borrowers, but, there is another factor in play that is far more significant than many people realize. In recent years, longer-term loans have come to dominate the passenger vehicle lending market. Between the first quarter of 2018 and the first quarter of 2019, the percentage of new vehicle loans that were 85-96 months in duration jumped by 38%. In other words, car loans for periods of more than seven years are becoming increasingly common.
While car loans of five to seven years saw slight declines during that period, loans of five years and up made up more than 71% of new car loans written in the first quarter of 2019. More than 62% of loans originated for used cars fell into the 61-84 month range. In other words, borrowers are stretching out car loan payments over longer periods of time. And, it turns out those borrowers are more likely to default than automobile purchasers who use shorter-term loans. As early as 2017, the Consumer Financial Protection Bureau (CFPB) was warning that default rates for six-year auto loans were about twice as high as those for shorter-term loans.
Purchasing for the Success of Your Automobile Loan
Of course, the fact that longer loans correlate with a higher default rate does not necessarily mean that the longer loan is the cause of the default. While there are reasons a longer loan may make it more likely that a car loan borrower will be unable to keep up payments, it is also likely that some borrowers spread out monthly payments over a longer period of time because they are already stretched thin financially.
On average, longer car loans carry higher interest rates. Although the difference in interest rates is relatively small, it can negatively impact a car loan in two ways. First, obviously, a higher interest rate makes the loan more expensive over time. And, that higher cost is magnified when interest is paid across six or seven or eight years rather than three. Another, less obvious reason higher interest rates negatively affect auto loan borrowers is that it takes longer to pay down principal, aggravating the widespread problem of automobile loan borrowers being underwater immediately upon purchase.
Imagine, for instance, that two borrowers purchase the same vehicle and make the same down payment on the same day. Each finances $32,000, approximately the average for a new car loan in late 2019. The first borrower takes out a 36-month loan at 4.21% interest – – the average interest rate for a 36-month loan. The second borrower takes out a 72-month loan at 4.45% interest – – the average for a 6 year loan.
The 72-month borrower will pay more than twice as much interest over the life of the loan, meaning that the loan cost thousands of dollars extra. Of course, the additional cost of the loan is even more significant if the interest rate is higher–which it will almost certainly be if the buyer has a subprime credit score–or if the loan is for seven or eight years rather than six.
But, that isn’t the most significant concern. The longer loan term also means that a smaller percentage of each payment and a smaller dollar amount goes toward paying down principal each month. After three years, the 36-month borrower owns a three-year-old car with no further debt. On the same date, the 72-month borrower still owes more than $17,000.
This often creates a trap for the borrower with the longer loan term. The car is more likely to be worth less than the outstanding loan value throughout much of the course of the loan, limiting options if there are problems with the vehicle, or the buyer suffers a financial setback and wants to get out from under the loan.
So, why do borrowers take out 6, 7, and 8 year car loans?
Often, it’s because a longer loan term means a lower monthly payment. In fact, the difference in payments can be quite significant. In our example above, the 36-month borrower’s monthly payment would be about $948. The 72-month borrower would pay just $507 per month. In some cases, these longer loan terms allow someone in serious need of transportation to purchase a vehicle on credit that he or she could otherwise not afford. But, the availability of these longer loans with lower monthly payments also encourages some buyers to purchase more car than they can really afford, and more than they would have if they did not have the option of extending the loan term.
Being aware of and thinking through these pitfalls before deciding on a vehicle to purchase or the loan term that best suits your circumstances can help avoid automobile loan default and the threat of repossession. However, life is unpredictable. Even those who have carefully considered their budgets and the long-term cost of a loan sometimes find themselves unable to keep up payments. If you have fallen behind on your car loan and are facing repossession, or your car has recently been repossessed in California, we may be able to help.