January 24, 2021

Higher used-car values are a wild card for negative equity

It is a dilemma born of a pandemic: Will vehicles purchased during COVID-19 help or harm consumer finances in the long run?

Automotive finance experts agree that longer-term loans at some of the highest monthly payments for new vehicles along with elevated used-vehicle values could result in an increase of underwater customers. That would likely push these consumers out of the market for longer periods and put them in worse shape when they return.

Even as transaction prices climb, however, the roller coaster of used-car values that occurred during the pandemic may have shifted factors in customers’ favor, not against. Economists and analysts at J.D. Power, Edmunds and Cox Automotive say lender appetites for a customer’s auto debt and long-term vehicle supplies could be key indicators of how new and used vehicles purchased in 2020 will perform in the years to come.

Alan Haig, president of Haig Partners, a buy-sell advisory firm in Fort Lauderdale, Fla., has heard from dealers that customers who purchased vehicles with values that rose considerably this summer naturally paid more than they would have last year. Larger loans for essentially the same vehicle could mean those customers have more to pay off before trading in that vehicle than their contemporaries. Dealers are worried, he said, about what that could mean for customers’ financial situations when they return to the market.

“It’s basically good to be a seller of a vehicle today. It’s not great to be a buyer,” Haig said.

Customers who purchased during the vehicle valuation vertex in July, where used values on certain vehicles jumped nearly $2,000 from the previous year, may have trouble in a future trade cycle, said Prime Automotive CEO Todd Skelton. Yet the majority of customers who purchased at other points this year likely only paid $800 or $1,000 more for a new or used vehicle, which may not pose a significant threat to their ability to repay a loan.

“I’m not sure that’s going to be terribly meaningful in three years,” he told Automotive News. “If the market is back pre-COVID, I’m not finding it to be a huge difference.”

After climbing for years, new-car price tags jumped even higher thanks to manufacturer constraints posed by the pandemic. The average price of a new vehicle sold in September was $34,911, according to Edmunds. That is 6 percent, or $2,087, higher than in September 2019. New-vehicle loan terms also inched up, to an average of 70.3 months from 69.7 months the year earlier.

In the short term, higher used-car values are benefiting vehicle trades, car dealers say, and depressing negative equity on vehicles coming back to the market. In fact, the average negative equity rolled into a new-vehicle purchase dropped last month to its lowest level in five years, Edmunds said, scaling back 18 percent to $4,559.46 from a record-high $5,554.94 in April.

Some customers “essentially drove their car for free for six to seven months,” Ivan Drury, Edmunds senior manager of insights, said last week. “All that deprecation that was supposed to happen was wiped clean.” Customers paid more for cars this summer, but they also got more bang for their trade-in, according to Tyson Jominy, vice president of data and analytics at J.D. Power. Transaction prices were up 6.5 percent year over year in September and well over $2,000 per vehicle, Jominy said. But monthly payments rose year over year by only $5 in September, according to J.D. Power data. He calls that “mind-boggling.”

“We have forces pulling in opposite directions,” he said. “Consumers are paying more, but dealers are dealing less. A third of consumers are bringing negative equity into the trade, and we’re making it go away.”

Prime Automotive Group, with 40 dealerships in six states, experienced an average of $1,500 in additional profits on used vehicles sold at the peak this summer. Elevated prices helped the group but also assisted customers trading in a vehicle, Skelton said. That additional value could have helped customers offset a hefty portion of the higher purchase price.

“If you’re trading a car in, you’re getting much more value from your car. But when you buy something else, you’re gonna pay more,” he said.

Still, not every dealership customer is benefiting from the price jump. Joe Opolski, used-car finance director at Roy O’Brien Ford in St. Clair Shores, Mich., said it’s been challenging to manage a customer’s negative equity while the value of off-lease vehicle inventory is inflated. “Profit margins are pretty thin,” Opolski said. “When we get a customer trading in a car to us on a vehicle [we overpaid for], it’s a little bit tougher to put a deal together.”

There are fewer levers at the dealership’s disposal for customers coming in with large amounts of negative equity, Opolski said. To put together a deal a lender is willing to accept, the dealership can discount the used vehicle, which would undercut profits, or add value to a customer’s trade-in, which the dealership will have to work out when it tries to sell that vehicle.

“There’s only so much room,” he said. “You have to know the lender programs well.”

Dealership outlook on customers’ financial positions moving through the pandemic period varies by market and brand. Toyota dealer Brian McCafferty said he can understand how some retailers are weighing a customer’s debt against used-car profitability. But he’s just not seeing that dynamic play out at his stores.

“We have dealt with more equity in trades in the last four months than we have seen in the last 10 years,” said McCafferty, owner of Avondale Toyota in Arizona and One Toyota of Oakland in California. “For a lot of people, their equity position increased when they went from their used car to their new.”

Another element that lowers the risk of negative equity unique to the pandemic period is the growth of consumer savings. McCafferty said his customers have fewer outings and vacations lightening their wallets. Those who remained employed without salary cuts also got a boost from government stimulus checks and tax returns. The average down payment has gone up about 15 percent at his stores, he said.

Additionally, the group shored up used-vehicle inventory at the right time. McCafferty said he purchased $5 million worth of used cars to sell at his dealerships in late March and early April. Those vehicles sold in 30 to 45 days, he said, and for record profits.

“Those same cars we bought for 25 percent off were going for over 35 percent their value,” he said.

As off-lease vehicles return to the market, used-car values are returning to normal levels. But as pandemic constraints persist, as well as the economic recession, McCafferty said he believes inventory could be tight for years. The rental car business will remain deeply impacted, and lacking the relief valve for excess inventory, manufacturers will be forced to hew production plans closer to retail demand.

Said McCafferty: “Moving forward, what really is going to determine what position these people are in is what the overall manufacturing of the industry looks like in 15 to 18 months.”