Generous Financing Offers Could Help Consumers Get Financially Healthy Again

by Ivan Drury, Edmunds' Senior Manager of Insights

April 2020 set a record with 0% finance deals accounting for 25.8% of dealership-financed new vehicle purchases, and many of these loans carried a term length of 84 months. These low-interest, long-term loans are receiving mixed reactions from financial advisers, auto industry  critics and consumers — just about everyone has an opinion on the subject. However, there is another aspect to these loans that draws even more ire: loans with negative equity. Let's dig into the data.

More Car Shoppers Are Underwater on Their Car Loans Than Ever Before
Two other records were shattered in April 2020. The share of new sales with a trade-in involving negative equity hit 44%, and the average amount of negative equity reached $5,571 — both all-time highs. These figures aren't reflective of incremental change or a broader, more gradual trend: The data shows an abrupt spike in negative equity.

Automaker Incentives During the Coronavirus Crisis Could Be a Shot in the Arm for Consumers with Negative Equity
If we take a look at April finance data, the sudden spike in loans with negative equity is certainly alarming. But there are some potential upsides for those who purchased a vehicle with negative equity in April 2020 compared to those who did so just a year ago, given the generous financing opportunities available in the market. If we compare the average loan term, monthly payment, amount financed, annual percentage rate (APR), down payment, and average interest paid over the life of the loan, consumers with negative equity fared far better in April 2020 compared to consumers with negative equity who made their purchase a year ago:

• While the average amount financed went up by nearly $5,000, the average loan term stayed relatively flat at 77 months in April 2020.
• The average APR is down significantly from 7.3% to 4.7%, due to the more attractive financing offers from automakers right now. 
• The lower average APR helped keep average monthly payments in check, increasing by only $15.
• Average total interest paid over the life of a loan financed in April 2020 is nearly $3,000 less compared to the average one year ago.

Most experts would traditionally advise consumers against trading in their vehicle if they're upside down on their car loan. However, the market is in a unique place right now due to the coronavirus pandemic: To help spur sales, automakers are offering extremely generous financing incentives, and consumers could use these offers to their advantage to put themselves in a better financial situation. Individuals who are underwater on their car loan or are trying to get out of a high-interest loan could essentially reset their loan and acquire a newer and nicer vehicle, for a similar monthly payment.

Automakers and Dealers Have a Unique Opportunity
Typically, the trade-in age of a vehicle directly correlates to consumer loyalty, with older trade-ins resulting in lower loyalty. Encouraging consumers to roll their negative-equity loans into a new purchase with a longer loan term would seem to be extremely risky for automakers. However, given how much better current interest rates are, consumers might be able to make a longer term loan work to their advantage with the appropriate guidance and education from lenders. And from a loyalty standpoint, they might be more inclined to stick with a brand that was there for them during a stressful time in their lives.

Dealers have the opportunity to sell extended warranties and service contracts to help allay the concerns of customers financing a long-term loan with negative equity. Gap insurance also presents a good selling opportunity since it can mean the difference between a consumer owing money on a vehicle determined to be a total loss in an accident versus walking away with no financial responsibility.

Some criticize the risk involved in longer loans because they outlive most warranties, but this has already been the case for over a decade: The average loan length hit 60 months in January 2003 and consumers haven't turned back since.

For the millions of consumers who are currently upside down on their auto loans, the opportunity to purchase a new car at a much lower interest rate is a very compelling prospect, especially as this recession has consumers reevaluating their monthly budgets.