Upside Down Auto Loans Slow Approvals

Two negative auto loan trends are emerging — especially for borrowers with subprime credit (defined as scores below 620) — due to distortions related to the current high prices for new and used vehicles, according to research from TransUnion, J.D. Power and S&P Global Mobility.

One trend is an increase in auto loan delinquencies, as inflation in the general U.S. economy makes it more difficult for some households to keep up with all their monthly payments, including auto loans, credit cards and mortgages.

For dealers and auto lenders, these trends could make it even more difficult for borrowers with subprime credit to obtain financing, analysts say.

The share of auto loans delinquent by 60 or more days was 1.69% for the first quarter of 2023, up from 1.43% a year ago. That’s the highest since a peak of 1.46% in the first quarter of 2008, before the Great Recession, according to the latest AutoCreditInsight report by S&P Global Mobility and TransUnion.

Satyan Merchant, senior vice president and auto business lead at TransUnion, tells Wards that, on average, auto lenders have already tightened approval standards in response to the uptick in delinquencies.

Tougher approval standards don’t appear to have significantly reduced demand for new vehicles, but used-vehicle loan originations are down, he says.

The other negative trend is an increase in loan-to-value ratios, which have grown as some customers stretch their household budgets to borrow more relative to the current value of their vehicles. 

The loan-to-value (LTV) ratio compares the amount borrowed with the value of the vehicle. An LTV of more than 100 means the amount borrowed is more than 100% of the vehicle’s value.

It’s common for auto owners to borrow somewhat more than the vehicle’s value. Finance & Insurance products such as extended-service contracts often contribute to a higher LTV.

But the higher the number gets above 100%, the more likely the customer will be “upside down” at trade-in time — that is, owing more on the vehicle than its actual resale value.

That can compel the borrower to come up with a bigger down payment or, commonly, to take out an even bigger loan on their next vehicle, partly to pay off the old loan. Or, they may not be able to get financing at all outside of a high-interest loan from a finance company.

According to a separate report from TransUnion and J.D. Power, the average LTV at loan origination was 125 in the first quarter of 2023,  up from 110 in Q1 2022 and 104 in Q1 2021.

High LTVs cut both ways for dealers. When lenders approve high LTVs, it’s easier for borrowers to get financed. The difficulty can be down the road when the borrower is upside down at trade-in or potentially after they’re in a loan and they can’t afford their monthly payment if they get behind on their bills.

And high LTVs at origination today could get even higher in the future on existing loans, assuming today’s high used-vehicle values eventually come back to earth, says TransUnion’s Merchant.

The used-car market hasn’t yet reached that point, he says. Recent models of used vehicles are still in short supply, reflecting production cuts during the pandemic and the ongoing shortage of computer chips.

However, high LTVs illustrate the affordability problem for new and used vehicles, especially for customers with subprime credit. Merchant says, “Sooner or later, the consumer can’t come up with a larger down payment.”