Despite Higher Trade-in Values, Negative Equity Remains a Lending Concern

By LAURIE GIESEN

The trade-in prices of some vehicles may have edged up in recent months, but that does not appear to have stopped the decline in the number of negative equity auto loans being made.

With lower gasoline prices causing trade-in values on some cars to increase, the spread between the value of the auto loans being requested and the cars being purchased on negative equity loans has narrowed. That led some auto experts to believe that financial institutions would be more willing to approve a greater number of negative equity loans.

But a continued tight credit market and other negative factors from a weakened economy kept that from happening.

“We’re starting to see some increase in the residual values of cars used as trade-ins, but there are so many other economic factors working against negative equity loans,” says Gary Dilts, senior vice president of global automotive operations for J.D. Power and Associates.

As a result, J.D. Power and Associates reports a continued drop in the number of negative equity loans being approved while the spread between the value of the loan and the car being purchased narrows.

Dilts’ thoughts are echoed by Art Spinella, president of Bandon, Oregon-based CNW Marketing Research Inc., who notes that the number of negative equity loans being approved continued to drop in recent months while financial institutions continue to tighten the availability of funds for these loans.

“Any uptick in prices of trade-ins has not really affected negative equity lending yet. It may be too early to tell, but right now lenders are continuing to tighten their criteria and requiring bigger down payments on loans,” Spinella says.

Indeed, Spinella believes negative equity lending has been hit much harder by the recent economic recession than other types of auto loans. “While getting new vehicle auto loans is a tad easier today than in November of last year, negative equity loans have not seen an increase,” he says.

The reason for this scenario? “There is a continued concern over residual or future used car values. The loans that are being made are on slightly higher credit scores. That typically means consumers who have put a fair amount down to begin with--either through a trade-in or cash or both,” Spinella says.

Still, a few finance managers in the market have begun to see some improvement in banks’ willingness to approve negative equity loans.

“The values of used cars are stronger and the banks have just started to loosen up for people who are at or just below average credit scores,” says one finance manager at a Texas-based Hyundai dealership. “Last month, we saw the first real indication that banks were starting to lend on lower credit scores for small and mid-sized cars. Although, they are still real tight on lending for SUVs and trucks,” he says.

But other finance managers report that the weak economy is still dragging down the availability of funds to make the loans. For example, while Dilts has seen a slight increase in the values of cars being used for trade-ins, especially for SUVs and other large automobiles whose values have been helped by recent lower gas prices, even those values are countered by the age of cars being traded in. According to J.D. Power, the average age of a trade in during fourth quarter of 2007 was 68 months while the average age was 76 months in the fourth quarter of 2008.

The net result: while the values of specific cars may have increased, consumers are actually getting less for trade-ins because they are coming in with older cars with more mileage.

And most finance managers are seeing that result in even tighter fund availabilities from financial institutions. “We really have not seen an improvement in the ability to fund negative equity loan applications,” says Stuart Krechmer, finance manager for O’Reilly Pontiac in New Square, Penn. “Credit continues to tighten and applications are less likely to be approved than they used to be, although it really all depends on the value of the vehicle and the credit score of the buyer.”

Krechmer says he started to see the tightening of funds for negative equity loans begin last summer and intensify even more by the fall.

The fact that there are fewer negative equity loans being made appears to be related more to the failure of financial institutions to approve loans than the number of applications. “Right now we’re seeing more people with negative equity situations than a couple of months ago,” says Brian Hathaway, finance director for Lankford Buick and Pontiac in Conshohocken, Pa.

Although Hathaway says he is seeing some increase in trade-in values, particularly in SUVs and cars coming off leases, buyers’ overall financial situations have deteriorated at a time when credit has tightened. Employment uncertainty and economic concerns have made it harder for consumers to put more cash down.

“The banks are requiring more than ever you need to put more cash down and have really good credit scores,” he says. “I’ve been in this business 27 years and this is the second-worst credit market I’ve seen. The only time it was worse was in 1982 when interest rates were around 18%.”

Another factor hurting the availability of negative equity loans is the crippled housing market. While it may appear that housing prices would not affect auto lending, that is not the case, Dilts says. A year or two ago, a number of car buyers with negative auto equity would take out home equity loans to pay for their cars. But with home values declining, many consumers are seeing declining equity in the homes that they may have used to secure auto loans.
Additionally, declining home equity is pushing many consumers’ credit scores down. And with many lenders only approving negative equity loans to those with the top credit scores, the percent of auto buyers who can get approved continues to decline.

“There is pressure by financial institutions not to lend on the middle and lower end of credit scores. People who have scores in the 700s can still often get any kind of an auto loan they want, but the market is tight for those below 700,” Dilts says.

And even for those auto buyers with prime credit scores, negative equity loans are sometimes not approved, particularly in geographic regions with high unemployment, Dilts adds. Some lenders are concerned that even if a particular consumer has always paid his bills and made good on loans, that could change if he loses his job.

The declining number of negative equity loans is not expected to change soon, according to experts. “There are still six million vehicles trapped in the pipeline and it is going to take about 18 months to work its way out. I don’t expect to see much relief in the negative equity loan market for at least 12 to 18 months,” says Dilts.

This article originally appeared in GreenLight Remarketing, a quarterly journal published by Santander Consumer USA Inc. and located online at www.greenlighttodrive.com.