Car Makers Reduce Leases, Increase Long Term Auto Loan
American car manufacturers, Chrysler, Ford, and General Motors (GM), have recently announced cutbacks or elimination of car leasing programs. Why? Because the programs have been money-losers for them due to unrealistically optimistic residual values (estimated future resale values). High residuals made for attractive low monthly payments. In an attempt to increase sales and better compete with foreign car makers, American manufacturers were too aggressive with both leasing and loan programs.
American car makers have heavily depended on large trucks and SUVs, the very vehicles that automotive consumers don’t want now. Resale values have plummeted on these vehicles. This means that when leasing consumers return vehicles leased more than a few months ago, the actual resale values are far below the residuals that the leases were based on. When the vehicles are sold, there will be big losses. These losses will continue for another three, four, or five years, depending on the the length of the leases. Consumers holding these leases will be protected.
Ford, Chrysler, and GM have announced that, in the future, leasing will cost more than in the past. In fact, Chrysler has eliminated lease programs altogether, although Chrysler dealers will have other sources of lease financing. Leasing will continue to be an attractive option for automotive consumers, even if the cost is somewhat higher.
Asian and European car makers, who are less dependent on large vehicles, have not announced cutbacks in leasing programs. In fact, because residual values on smaller, fuel-efficient vehicles will remain high, leasing will be as attractive for these vehicles as ever, or even more so.
Chrysler has announced that they will replace leases with long-term loans that produce payments as low as shorter-term leasing. They intend to promote long 72 month (6 years) loans. They are replacing one problem with another. From their point of view, it might help move cars, but it takes them twice as long to get their money back as on a lease. Once again, they are mortgaging their future, if there is a future, for the sake of short-term sales.
From the consumer’s point of view, it’s not a very good solution either. With a 72 month loan, they can indeed get a monthly payment about the same as a 36 month lease for the same vehicle. However, the 72-month loan buyer will be upside down for most of the loan term, meaning they will not have any ownership equity for trading or selling until about the last year of the loan, depending on down payment and interest rate. Since many people tire of their vehicle after about three years, these people will find that getting out of the loan will be expensive and troublesome. Furthermore, since most manufacturers’ warranties, including Chrysler’s, expire after three years, these people will be exposed to out-of-warranty repairs for three more years, for a vehicle they have little or no ownership equity in. They will question why they should spend money repairing a vehicle on which they have negative loan equity.
Another exposure for long-term borrowers is that insurance companies will only pay for a car’s current replacement value, not the amount still owed on a loan, if the vehicle is stolen or totaled in an accident. If the borrower is upside down, as he would be for most of the 72 months, the difference between loan balance and insurance payoff could be thousands of dollars. Gap insurance is the solution to this problem, but many auto consumers don’t know about it and won’t have it. Others will question it’s value and decide not to buy it. Dealer’s may not mention it, either because they don’t offer it, or because it increases overall cost and might cause the customer to balk at the car deal.
Leasing, on the other hand, is shorter term for the same monthly payment. The leased vehicle is always under warranty, assuming a three year lease. Gap insurance is automatically included. No down payment is required. Even if lease costs increase, which seems to be inevitable, there will continue to be good reasons to consider it as an alternative to buying, especially when compared to long-term loans that American car makers will be offering.
Al Hearn is founder, owner, and operator of two popular automotive consumer web sites, Lease Guide and Used Car Advisor, which provide free auto buying, selling, leasing, and financing advice.
