The Impact of Longer-term Auto Loans on Lenders


- Golden Eagle Insurance Team

There are nearly 270 million vehicles registered in the United States, making the country the second largest vehicle market after China. Despite having 1.2 cars per driver, the US continues to see growth in new and used auto sales and auto loan origination. Lenders know that auto loans today look entirely different than those from the past. Nowadays, most loans are made with terms of five to seven years.

As car designs improve, with more custom features and enhanced technology offerings, drivers are clamoring for bigger and better automobiles. These high-end vehicles come at luxury prices, which lead drivers to pursue longer loan terms to lower their monthly payments for affordability.

Both drivers and lenders face the risk of financial loss with longer-term auto loans. For drivers, they may end up owning the car past its original warranty expiration date and the car will depreciate at a rate faster than the loan balance causing them to be “upside down” on their loan.  Often, drivers could find themselves owing money on top of having to buy a new car.

The main risks faced by lenders are higher default rates and deficiency balances. Longer term loans are often made to drivers who have riskier credit profiles. In either of these situations, lenders can incur significant losses. Loans made for longer terms also have a higher probability of insurance lapses so the risk of uninsured losses to the lender is increased.

How Can Drivers and Lenders Mitigate these Risks?

Drivers can protect against the risks of expired warranties and gaps in coverage by purchasing an extended warranty and Guaranteed Asset Protection or GAP waiver plans. Both of which could be sources of additional revenue for lenders.

There are risk management programs that protect the lenders as well. Lenders could leverage collateral management systems, such as global positioning systems (GPS) and starter interrupt devices (SID), or implement an Auto Loan Default Protection program.

Another risk that lenders need to protect against is lapses in the borrower's insurance. Blanket Vendor Single Interest (VSI) protection covers a lender’s entire consumer portfolio from these losses. Some versions include optional tracking services in addition to standard blanket coverage. Collateral that is repossessed or unrecoverable can also be insured through Blanket programs.

The automotive market in the US is exciting. There’s always a new tech integration or design coming out. If the economy remains relatively stable, customers are likely to continue reaching for those impressive, best-in-class editions, which could continue to fuel growth in longer-term loans. Purchasing supplemental insurance like GAP for consumers or VSI for lenders and implementing risk management solutions could help mitigate financial losses for both parties.

Check out our blog post: As car values struggle, VSI and Gap in demand for more information about how car values are affecting lender risk management as well.

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