Only employment and credit are more important than used vehicle values to the health of the automotive industry as indicated by our research. We say this because 86% of new-vehicle sales, on average, are financed, and under normal conditions, those vehicles are traded within three years. Since most auto loans have a 60-72 month duration, the majority of vehicles traded at the 3-year mark are not paid- off. The level of equity in these loans directly affects consumer behavior and, in large part, determines when their current vehicle will be traded for a new vehicle. The frequency with which this very large group of consumers replace their vehicles has a direct impact on the velocity of new-vehicle sales. The time to equity indicator is updated quarterly and provides long-term insight into the health of new- vehicle replacement cycles.
Thirty-two months seems to be the point at which Time to Equity starts to impact new-vehicle sales velocity. The chart below illustrates the average new-vehicle vehicle payment based on average ATPs, loan terms and interest rates for the respective year compared to an adjusted payment which takes equity/inequity at 32 months into account. Pay very close attention to what happens when the two lines intersect.
Aside from reducing the velocity of new-vehicle sales, increased Time to Equity has another negative side effect, higher delinquency/default rates. The explanation is simple, most auto lenders believe longer loans have a higher the risk of default since the ability of the borrower to repay is more likely to change. However, since auto loans are rarely held until maturity, the risk is not in the length of the loan at origination. The real risk is in the amount of time it takes for the value of the vehicle to meet or exceed the principal balance owed on the loan.