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Continued Access to Easy Credit Underpins Rising US Car Prices, but Subscriptions Could Reduce Market Risk

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By: Eric Totaro

New and used car prices continue to rise in the US despite several factors pointing to a stagnating or shrinking market. The average age of a vehicle on the road reached a record 11.6 years in 2016, suggesting that Americans are holding onto their cars longer. Demand for sedans and coupes has waned, while SUVs and pickup trucks have become more popular. Yet new vehicle prices increased around 1% year-over-year as of August, reaching an average of nearly $35,000, while used vehicle auction prices rose 8% year-over-year as of October.

Lower barriers for automotive lending and long-term loans are incentivizing consumers to purchase more vehicles. The lower monthly payments that result from long-term auto loans signal that consumers are demanding expensive vehicles with the latest technology, but new and used vehicle prices risk crashing due to an increasingly levered consumer base burdened by negative equity. The emergence of subscription-based ownership programs offers a possible solution to this problem through better fleet management, but risks alienating lenders in the long term.

Many Buyers Aren’t Paying off their Vehicles

In the event of a macroeconomic downturn, underwater auto borrowers will walk away from their cars in a similar fashion to how underwater homeowners walked away from their houses during the mortgage crisis of the late 2000s. According to the Consumer Finance Protection Bureau, 42% of auto loans in 2016 carried terms of six or more years, compared to 26% in 2009. Euromonitor International predicts that the outstanding real value of auto loans will grow at an average rate of 2.7% per year between now and 2022. Among forms of consumer lending, only the outstanding balance of credit card debt will grow faster.

Could Longer Term Loans Signal Changing Consumer Preferences?

Beyond a strong economy and low gas prices fueling SUV and pickup truck sales, a propensity for lower monthly payments and longer loan terms could signal a willingness among consumers to embrace a subscription-based ownership model. Other industries, such as mobile phones, have shifted from a one-time payment plus contract model to amortizing the cost of a handset over a period of years. These monthly payment plans – often offered with little or no interest – have helped new phones approach four-figure sticker prices. Consumers can often trade-up to the newest phone models after as little as one year and pay around $45 a month toward the cost of the phone. Passenger cars have become more tech-laden, and it is often this technology that differentiates one vehicle from the next.

With increasing complexity stemming from insurance and maintenance plans, subscription models simplify vehicle ownership by providing consumers with one out-the-door price and an easier way than buying or leasing to drive the latest vehicles. Cadillac, Volvo, Porsche, and Ford have all rolled out subscription ownership models in recent months.

What Will Happen

While a gradual tightening of lending standards could bring the market back to low-risk levels, automakers and auto lenders are benefitting from consumers opting for longer loan terms with lower monthly payments. The introduction of subscription ownership models helps automakers avoid a glut of used vehicles by managing which models are included in a subscription program and how often vehicles are swapped out, but this risks alienating lenders in the long term. In the short term, however, a growing subscription base would help automakers avoid plummeting car sales and prices in the event of a credit crunch by establishing direct access to their consumer base.

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