Underwater Car Loans Are Bigger Than Ever
This is bad for trade-ins, as well as the economy in general.
In light of declining sales, car dealers have become more loose about exactly to whom they will sell cars. We're not just talking about the sketchy "buy here, pay here" dealers, either. Mainstream dealers are playing loose and fast with car loans as well.
For example, auto researcher Bozi Tatarevic recently tweeted a chart of credit scores and loan terms to qualify for a Kia Stinger. The chart goes into relatively low credit score numbers, though at high interest rates. Even at a 580 credit score, you can own a new Stinger GT2 for just $1,009 per month for 72 months.
Even though the Stinger is a rather awesome car, that's a lot of coin for a Kia. After factoring in the 11 percent interest rate, the $53,000 loan inflates to more than $80,000, which is probably the most expensive Kia ever. As good as the Stinger is, it's not $80,000 good.
What happens in a few years when the owner wants to trade their Stinger in on a new (perhaps less expensive) model? Since the Stinger is new we don't know how quickly it will depreciate, but depreciation will happen. Let's be optimistic and say the car is worth $40,000 when traded in. That's not nearly enough to repay the loan.
Though not to this extent, this is exactly what happened to me when I traded in my 2014 Subaru BRZ, which I bought new, on a 2015 WRX. During the three years I had my $25,000 BRZ it plummeted $10,000 in value. North End Subaru managed to roll me into a WRX for no additional money down, but the amount I was underwater on the BRZ was added to my WRX loan.
Now, a year after buying my WRX, I still owe a bit more on it than it's worth. I'm planning to hang onto the car for a while, and since WRXs hold their value quite well in New England where I live, I'm hoping to rectify the problem that way. If I'd bought yet another high depreciation car, I'd have no choice but to roll that into my next car loan or keep the car until it's paid off regardless of the cost. The only quick fix would be to crash the car, total it, and let gap insurance sort it out, assuming I'm not busted for fraud.
In the meantime, more and more people are ending up in this situation. Bloomberg reports that nearly one-third of all trade-ins are now worth less than their loans, up from about a quarter just ten years ago. What happens if suddenly the economy busts and many people can no longer afford their car loans? The bubble bursts, just like the housing bubble did in 2008. Cars will be repossessed and sold at a significant loss, which hurts the economy as a whole.
To be sure, the harm from a bursting auto loan bubble wouldn't be as severe as the housing bubble. Cars cost less than homes, so significantly less money is tied up in auto loans than mortgages. But there would still be an effect, both from the loans themselves and people losing their transportation to work. It wouldn't be fun for anyone.