Yet, it has always puzzled me the way that vehicle sales are reported. Specifically, while they are “seasonally” adjusted, they are not adjusted for population growth. With a continually growing population, we would expect that auto sales generally increase over time. And over the long term, that is what we find. The longer term chart below going back to the late 1960s from calculatedriskblog.com shows that the number of auto sales in the U.S. has rather steadily increased over the past four or five decades. In the 1970s and 1980s yearly sales generally ranged from about 10 million to 15 million. (The auto sales spikes during the 1970s were due to gas price spikes which spurred millions to give up their gas guzzlers for more fuel-efficient autos.) From the early 1990s a steady climb in auto sales from about 12 million per year reached a plateau of about 17 million by the early to mid-2000s before the roller-coaster of sales collapse and resurgence over the last decade.
While the general trend over the past decade remains the same we see that the sales increases, after reflecting population growth do not appear so robust. In fact, current adjusted yearly sales of about 16 million is generally comparable to the level from the early to mid-2000s before the financial downturn set in. Going back further, adjusting for inflation, the current level of auto sales is comparable to a level of about 11 million in 1970, 12 million in 1980, and about 13.5 million in 1990.
Interestingly, the population-adjusted sales level of today is approximately what existed during those recessionary periods of 1970, 1980 and 1990 (note the blue columns in the chart above, indicating recession). And each of those times were period of very weak auto sales. In other words, what is celebrated today as a very robust auto market would have been associated with recessionary conditions in past decades. If today’s auto sales were comparable to those of the second half of the 1980s, a generally robust period of auto sales, you would be seeing yearly sales in the area of 21-22 million a year.
In addition, we also need to look at how today’s auto sales are generated. We know of course, that the very low interest rates engineered by the Federal Reserve generates many buyers (and borrowers) of autos that in past decades wouldn’t have been able to pay the necessary interest rates for their car loans. A remarkable aspect to the levels of past auto sales compared to today is how strong they were then despite much higher interest rates and significantly shorter loan terms.
In the early 1980s for instance, auto loans on new cars were typically in the range of 10%-15% per year, according to data from the Federal Reserve Bank. And despite those high interest rates, as well as struggling through a recession, after adjusting for population, auto sales were comparable to levels seen today. By the mid-1980s, a period of strong auto sales, interest rates were lower, but still generally in the range of 7%-9% from auto dealers, and 12%-13% for bank loans.
In contrast, according to information from Experian Automotive, the average interest rate paid on a new car was 4.8% in the second quarter of 2015, which includes the riskiest segment of borrowers, subprime borrowers, who pay significantly higher interest rates. According to Experian, 70% of today’s borrowers are either “Prime” or “Super Prime” borrowers, with credit scores between 661 and 780 and above 780 respectively (on a scale of 850). Those Prime and Superprime borrowers took out loans at an average interest rate of just 2.7% and 3.6%, respectively, in the second quarter of 2015. To be sure, low interest rates have greatly expanded the auto market, and the amount of car consumers can finance.
The second major difference in auto borrowing since pre-2000 is the length of loan terms. While it may seem incredible to believe now, the standard auto loan taken out before the mid-1950s in the U.S. was just 24 months. In the 1950s, 36-month loans became more common and coincided with that decade’s auto boom. By the early 1980s, loan lengths had slowly crept upwards to a little under 4 years, about 45 months. In 1984-85, auto loan terms again took a jump upwards, from about 46 months to 51 months.
Average auto loan lengths have continued to increase. By 2015 the average term of a new car loan was 67 months, which it was 62 months for a used car. The loan length category that is surging in popularity, an increase of 20% within a single year from 2014 to 2015, is the loan length of 73-84 months. Those loans of more than 6 years are now accounting for about 29% of new (and 16% of used) auto loans. Seventy percent of new auto loans are for terms of 5 years or more.
It should be noted that such long-term, high interest rate loans are very risky, particularly for subprime borrowers or for those borrowing to buy used cars. Last year, the average subprime borrower (credit score 501-600), took new auto loans at an average of 10.9% on a new car and 16.4% on a used car. The interest rate on new loans for those “deep subprime” borrowers (scores 300-500) was 14.5% for a new car and 19.8% for used cars. Across the entire spectrum of borrowers, used car rates were 9.1%.
Coupling high interest rates and long loan terms makes auto financing an expensive proposition for many consumers. A $20,000 loan at 15% for five years (60 months) means the borrower will pay more than $8,500 in interest over the life of the loan. As a result of the high interest rates on their auto loans, higher-risk borrowers have higher monthly payments than prime borrowers. That’s despite generally having smaller loan balances (and buying less expensive cars) than higher-credit borrowers.
Auto makers are increasingly willing to take on risky borrowers who are taking out long loan terms at high interest rates. To boost sales, companies are extending more and more credit to riskier borrowers. Average credit scores of auto loan borrowers over the last several years have been falling, according to Experian. After peaking in the 2nd quarter of 2010, average credit scores for new auto loan borrowers, have been steadily declining, from 734 in 2010 to 709 in 2015. (A similar pattern is seen with used car loans with average scores falling from 658 to 645 over the five years.) Average credit scores for new and used car loans is now lower than in the “easy credit” days of early 2008.
As a whole, the auto industry is booming, at least compared to most of the last 7 or 8 years. Sales are increasing sharply as a wider pool of applicants is invited into showrooms with longer loan terms and relaxed credit demands. But make no mistake, auto sales are growing because auto loans are growing even faster. From the second quarter of 2013 to the same quarter in 2014, total auto loan balances in the U.S. grew from $752 billion to $840 billion, an incredible 11.7% increase, far greater than the total increase in auto sales. From 2014 to 2015, loan balances increased sharply again, increasing 11.0% to $932 billion.
By the end of 2015 total auto loans outstanding in the U.S had surpassed $1 trillion, an increase of 50% in under five years. It is impossible to know how many of today’s auto sales would not take place if interest rates were at normal levels or if so many risky potential borrowers were not given serious credit considerations, at any interest rate. The trend in today’s auto market coincides with the easier credit conditions typical near the peak of a business cycle, but is amplified by the distortions in the credit and lending markets.
Is today’s auto market a strong one? I’m not so sure. If there was currently a strong auto market in a strong economy you would see people having more savings to put towards a new vehicle. That isn’t happening. Since 2010 the percentage of new car buyers financing auto purchases has been consistently increasing, from 80.2% to 85.8% in 2015 (for used cars, the percentage financing has increased from 47.2% in 2010 55.5% in 2015.) In a strong auto market you would see shorter-term loans, not longer. You would see total auto loan balances growing more slowly than the increase in auto sales themselves. And you would see the average credit scores for borrowers going up as auto lenders become increasingly picky about who to lend to.
According to Experian, in 2015, a majority (54%) of 2006 model vehicles still had a loan on them, as do nearly a quarter of year 2000 model vehicles. The situation where a majority of nine-year-old vehicles still have loans on them is a consequence of so many borrowers being “under water” on their loans, and needing to roll those old loan balances onto their new loans. That in turn is a consequence of long loan terms, often combined with debilitating interest rates.
Cars and trucks are not appreciating assets. Long-term auto loans are a risky business for any borrower and in any economy. Stretching out loans to 6, 7 or even 8 years on a depreciating asset and with at about any interest rate nearly ensures you will be upside down on your loan for most or all of the time you are making those payments. According to Consumer Reports, a new car bought at $34,000 will depreciate to $21,420 in two years and to $12,240 within five. With the average new car held for 6.5 years before being traded, a sizeable percentage of borrowers will be trading their cars in before their original loans are paid off. Perpetual auto loan borrowers may be good for the banks and auto makers, but they’re not adding to the financial stability of American households.