7-Year Loans Require Greater Vigilance, Higher Pricing

tape2As cars get more expensive and consumer budgets get tighter, loan terms are extending to keep monthly payments affordable.

The average loan term on all new cars was 66 months in the fourth quarter of 2014, according to Experian, up a month from the prior-year period. Among new-car loans, 25.9% had terms between 73 and 84 months, while 14.8% of used-cars loans were that long, according to the company. Those figures are up sharply from the year before.

Longer-term loans carry more risks, for sure. As the vehicle ages, chances grow that something will go wrong with it, which also increases the odds that the borrower will stop paying.

Unsurprisingly, the charge-off rate on loans with terms between 73 and 84 months is almost seven times higher than on 60-month loans and 15 times higher than on 48-month loans, said Sean Worthy, director of auto sales and business development at Pentagon Federal Credit Union, citing Experian data.

Even more worrisome, customers with the weakest credit are the most inclined to take out the longest loans. According to Experian, the average loan term on nonprime, subprime, and deep-subprime new-car loans was more than 71 months at the end of 2014. That compares with less than 61 months for super-prime customers and 68 months for prime customers.

So how do lenders mitigate these greater risks?

The first step is preparation.

Ally Financial piloted and monitored its 84-month product for two years before rolling it out to all 50 states, said Tim Russi, the company’s president of auto finance. “This approach enabled us to design a product that would offer consumers another choice to consider when purchasing a vehicle,” he said.

The next step is constant vigilance.

“Closely monitoring a consumers’ credit history will help any lender mitigate risk,” Worthy said. “Credit history in terms of both length of credit and risk tier provides a good benchmark to help determine loan success. There is a definitive correlation between the length of one’s credit history and the probability of a new or used loan defaulting.”

PenFed caps loans terms at 72 months.

Ally’s Russi credited his company’s “robust underwriting standards, with a focus on ability to pay” in mitigating risk, as well as “pricing for risk appropriately.”

Navy Federal Credit Union only makes 84-month loans on a case-by-case basis, such as to older members buying cars that cost at least $30,000, said Gary Guthridge, manager of Navy’s consumer lending portfolio. It won’t make such a loan to a younger member with a $10,000 loan who wants a longer term “just to get to a payment,” he said.

Seven-year loans comprise less than 10% of Navy’s auto loan portfolio. That percentage has remained stable the past several years, a trend Guthridge attributed to the relative young average age of its membership base, which limits eligibility.

Actually, Navy is willing to extend terms to 96 months on vehicles that cost more than $50,000, although Guthridge said the credit union makes “very, very few” of those loans.

Navy is also willing to extend terms to eight years on auto loan refinances, but charges higher rates the longer the loan. For example, the rate on a 96-month refi is 4.49%, compared with 3.99% for 84 months, 2.29% for 72 months, and 1.99% for 60 months.

For longer term loans, PenFed’s Worthy suggested that the borrower purchase GAP insurance to ensure that any remaining loan balance is covered in the event of a total loss.

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