Declining Used Car Prices Could Cause Trouble for Loans - Investopedia

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Used car prices dropped by 7% in the third quarter of 2022, leading to a steep rise in defaults, according to a report by Bloomberg. In response, one major lender has pulled back on originating new loans, while others have tightened underwriting to limit potential losses.

Key Takeaways

• Used car prices are starting to decline after runaway gains created by the global coronavirus pandemic.
• Lenders have seen more borrowers default on their loans as the prospect of negative equity increases.
• In response, some lenders have tightened their underwriting standards while others have cut back on loan production to limit potential losses.

Trouble May Be Brewing for the Auto Loan Industry

During the height of the coronavirus pandemic, used car prices experienced unprecedented gains as a result of a microchip shortage that stalled the production of new vehicles. The situation pushed car buyers to used lots, creating a high-demand environment that pushed used car prices up 28% in 2021, according to Kelley Blue Book.

While those prices remain higher than pre-pandemic levels, they're starting to come down, with an average decline of 7% in the third quarter of 2022. The price drops mean that more borrowers are left underwater on their loans, owing more than the value of the car.

As a result, auto lenders are already experiencing an increase in loan defaults. For Ally Financial, the second-largest auto lender in the country, charge-offs for retail auto loans quadrupled in the third quarter.

The lender anticipates that charge-offs will increase to 1.6% in 2023, up from 1.05% in the third quarter, but points out that those rates are below pre-pandemic levels, so it doesn't anticipate changes to its loan production.

Wells Fargo also experienced an increase in write-offs for auto loans it originated toward the end of 2021. The national bank has tightened its underwriting standards as a result, making it more difficult for borrowers on the lower end of the credit spectrum to get approved.

Fifth Third Bancorp has said that it's pulled back on originating auto loans to cope with the risks it faces. Overall, auto loan originations for the entire industry dropped by a staggering 40% during the third quarter from the same period the previous year.

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Declining Used Car Prices Could Cause Trouble for Loans - Investopedia
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