Originally Posted by NY Times
Owing More on an Auto Than It's Worth as a Trade-In
By DANNY HAKIM
DETROIT, March 26 - An increasing number of new-car buyers are finding themselves owing more than their trade-ins are worth.
In the car industry, this phenomenon is known as the upside-down car loan, and it has escalated during the car-lending spree of the last three years. While automakers are enticing customers that have good credit histories with no-interest loans, they have also been offering six- and seven-year loans to customers who want to keep their monthly payments down.
A new study from J. D. Power & Associates, released on Thursday, says that 38 percent of new-car buyers are upside down on their trade-ins, up from 25 percent in 2001.
At the same time, the average term of car loans has increased to 58 months today from 53 months in 2001, making it more difficult to build equity in a car.
The industry's loan practices have led to robust auto sales throughout a period of economic uncertainty. But booming sales of new cars have, in turn, contributed to diminished residual values of older ones. And lower residual values is a key factor that adds to the upside-down problem.
Some auto analysts and economists worry that this trend could damp new vehicle sales, because people may be less inclined to buy a new care when they still owe money on their old ones. And it could also lead to more personal bankruptcies.
"Right now, automakers are legitimately trying to sustain demand and market share through aggressive manipulation of finance instruments," said Tom Libby, an industry analyst for J. D. Power, "but the long-term ramifications of these efforts are questionable."
"If this trend continues," he added, "eventually the factory will have to provide a heck of a lot of assistance, which is not good news for the automakers."
But automakers, fighting for sales in a market saturated with new vehicle production, are already contributing record amounts of incentives per vehicle, through rebates, free financing and other offers, to keep customers coming back.
Incentives costs reached an average of $2,459 a vehicle in February, up 15 percent from a year earlier, according to Edmunds.com. Domestic automakers paid the most, at $3,409 a vehicle, on average.
Edmunds tracking data showed 27.9 percent of new car buyers with upside-down loans in January, up from 24.5 percent two years earlier. And the average buyer with an upside-down loan was $3,763 in the red.
Mr. Libby said the upside-down problem was more acute for domestic automakers, but J. D. Power, the consulting firm, is not specifying by how much.
Domestic automakers say the issue is not their most serious problem.
Paul Ballew, the chief industry sales analyst at General Motors, said in a conference call earlier this month that G.M. had not seen its upside-down loan rate spike to the level suggested by studies similar to J. D. Power's.
He also said that his company had been pulling back from offering longer term loans.
"It's one of the reasons why we've been pulling back and making sure that 72 month loans don't spike up, and that we are restrained there, and that we're certainly looking at other options," he said.
"But I can't confirm or make sense of some of the other estimates that have been submitted out there in the industry, no matter how hard we've scrubbed and looked at the numbers," he added.
George Pipas, the Ford Motor Company's chief industry sales analyst, said, "all other things being equal, you'd prefer to have zero percent upside down." But he said that rising household incomes and other economic factors offset upside-down loans.
"We don't consider it an onerous problem because of the economic backdrop against which it's occurring," he said, adding, "Net-net, the consumer is positive."
Mr. Libby said the entry-level luxury segment - where companies like BMW and Mercedes sell cars for $30,000 or less - was a particularly troublesome area because it is "known for having customers who want a luxury car and are stretching" their budgets to buy one.
Paul Taylor, chief economist at the National Automobile Dealers Association, said that "with a significant percentage of customers, it can be a problem."
But he is forecasting improved residual values, especially by 2005 and 2006. Part of the reason is that the effects of a late-1990's leasing boom will have passed, because those cars will have already come off leases and been sold back into the market.
"If we thought the drop in used car prices was going to continue for 10 years, it would be a big deal," he said. "Our best information tells us that prices are currently firming up and are going to increase in 05 and 06."
