The wave of easy credit and longer auto loans has left a record percentage of consumers trading in vehicles that are worth less than what the borrowers owe on their loans.
In auto-finance parlance, these folks are underwater, or upside down. They already are affecting the market as automakers boost incentives and subprime lenders monitor their delinquency rates more closely.
So far this year, a record 32 percent, or nearly one-third, of all vehicles offered for trade-ins at U.S. dealerships are in this category, according to research by Edmunds.com. When people with underwater vehicles go to buy a new vehicle, they must add the difference between their loan balance and the vehicle's value to the price of the one they want to buy.
For perspective, the lowest the underwater percentage has been was 13.9 percent in 2009, the depths of the Great Recession, when credit was tight. The previous high was 29.2 percent in 2006, about when the housing market was near its frothiest point.
"There's been a lot of water building behind this dam for some time because of higher transaction prices, lower down payments, and long-term loans," said Greg McBride, chief analyst with Bankrate.com, a consumer finance information service.
The average new car loan is for 68 months, according to Experian Automotive, which tracks the auto finance market. But subprime borrowers, generally those with FICO credit scores in the low 600s or lower, are borrowing over an average of 72 months, or six years.
While those loans reduce monthly payments, they also mean that the buyer's equity, or the portion of the loan principal paid off, grows more slowly than the vehicle depreciates.
"It's problematic for the consumer because there's no foolproof way to eliminate his financial exposure," McBride said. "If the car gets stolen, is totaled, or you get new-car envy while you're upside down, then it's a big problem."
This is happening as the average selling price of a new vehicle is near a historic high of about $34,000. Some of that increase is driven by consumers' preference for larger, fully equipped pickups, SUVs, and crossovers.
The result is consumers borrow more to get the vehicle they want. The average new-auto loan was $29,880 in the second quarter of this year, according to Experian Automotive. That's 4.8 percent higher than a year earlier.
Credit agencies, such as Moody's, Standard & Poor's, and Fitch, so far, have expressed mild concern about the trend. Their focus is on the $38 billion market for securities backed by auto loans.
Fitch reported that 60-days-plus delinquencies on subprime auto loans rose to 5.05 percent in September, the second-highest level since 2001, and 13.2 percent higher than a year earlier.
"When you look at recessionary levels where unemployment was near 10 percent in 2009 and late 2008, we touched 5.04 percent," said Hylton Heard, senior director at Fitch Ratings. "Today you're pretty much at that peak."
Fortunately, unemployment is down to 4.9 percent nationally. Prime borrowers have a 60-day delinquency rate of only 0.44 percent. Those factors tend to offset the higher risk in the subprime market.