Squeezed from every direction, many automotive consumers are finding themselves on precarious footing, shut out of credit access, deep in negative equity on existing loans, or stretching thin to force barely palatable payments.

Auto dealers are more often faced with trying to help strapped customers either keep their older wheels running or manage to buy new ones, or at least new to them. The challenge can be tough.

More than a quarter of new-vehicle trade-ins in the second quarter were under water for a four-year peak of 27%, Edmunds reported. The average amount owed on the loans was $6,754, up 8% year-over-year, and the amount of negative equity on the loans also grew, those with more than $15,000 owed also jumping 8%.

At the same time, more auto borrowers who also owe money on student loans fell into the subprime segment after federal loan forbearance ended last fall, according to Cox Automotive. It quoted an executive with data analytics provider FICO who said a student loan delinquency was added to about two million auto borrowers’ credit files in the first quarter, raising the share of subprime borrowers almost a percentage point.

Set against the backdrop of inflated prices for both new and old vehicles, along with still-elevated interest rates, and consumers would appear to have few places to turn.

“Affordability has been an issue for over a year,” said Cox Lender Solutions Strategist Andy Mayers in late April during the midst of a trade tariff-inspired car sales surge as consumers moved to lock in pretariff prices. “As soon as interest rates went up, it made it really hard for some consumers.”

Light in the Darkness

Auto dealers, who proved their flexible business acumen during the Great Recession and the pandemic, can also adapt in current conditions, Mayers said, though he allowed that interest rates and vehicle prices are making it more challenging than ever.

Auto loan delinquencies, though down in the first quarter and steady in the second quarter, surpassed a historical high in the fourth quarter of last year that was set during the recession in 2009.

One bright spot in the storm is hidden in the student loan delinquency picture: consumers tend to prioritize auto loan payments over student loan debt, Shams Blanc, FICO vice president and head of scores for the auto industry, told Cox. 

“Consumers are four times more likely to fall behind on student loans than auto loans. Cars remain essential and auto payments continue to come first.”  

Still, a greater share of subprime borrowers – a segment already shrunken during the pandemic due to higher interest rate and auto prices – doesn’t help with already limited affordability. In addition, compromised loan performance is poised to continue despite any Federal Reserve rate cuts. Lenders will therefore minimize risk on subprime borrowers, keeping auto loan rates high, Cox says.

Help Is on the Way

Dealers aren’t without options to help shoppers make a way and shore up profits at the same time, experts say. 

“Dealers with expertise and know-how, especially from the finance department, are best quipped to navigate this kind of stuff,” said Joseph Yoon, a consumer insights analyst with Edmunds. “There’s no easy way around this except having had prior experience in dealing with these kinds of situations.”

Either the customer with heavy negative equity pays off the loan to remove the debt or stops making payments on it and has the car repossessed at the cost of a solid credit score, or manages a loan refinancing or a new loan to roll the negative equity into, spread across eight or nine years to lower monthly payments. Those scenarios are becoming harder to fenagle because of the high interest rates and car prices, Yoon said.

“They’re difficult conversations to have with strangers,” he said. “‘What can you afford? And we really mean it when we say that. Your options are very limited.’”

Yoon recommends auto dealers have relationships with as many lenders as possible to help them help stretched customers.  

“If they’re small and work mainly with a captive lender and one other bank, it becomes harder to find a solution. If they have a captive and two or three national banks, maybe a local credit union or two, then there’s options to see which lender is willing to work with a customer.”

Mayers agrees. He advises that dealers shop multiple lender institutions to get the best terms they can find, a move he’s seen more of them make recently by taking advantage of tech tools to help them compare.

In addition, he said dealers can use vehicle valuators and payoff quote services to determine if individual customers have equity in their trade-ins or are upside down.

Many strapped consumers have been turning to used-car inventories to make trading more realistic, which might seem like an obvious solution to negative equity and low credit scores and all the rest. Many dealers are even selling 5-year-old cars. But going used has its own challenges. The experts, though, said there are ways dealers can shore up that end of their business.

First the bad news: Used vehicles are in shorter supply due to all of the affordability issues on top of pandemic-era supply chain bottlenecks that reduced new-vehicle inventories. So used prices are also inflated and used vehicles harder to come by. On top of that, used-vehicle loans are more challenging to secure than new-vehicle loans, Yoon said.

“Interest rates are higher for a used vehicle … and some banks won’t finance them too long if they over X number of years old,” he said. “You have to strike a balance between the car being new enough and enough value so when you tack on a couple thousand dollars in negative equity it doesn’t trigger the loan-to-value flag from the bank.”

Dealers can make their stores more competitive for the used-vehicle shopper by sourcing as many cars as possible, including investing in outbound marketing to draw more trade-ins. Yoon said.

“Dealers who’ve invested in that kind of marketing and flexibility in how they cater to customers will be suited to handle the uncertainty.”

It’s Not So Bad After All

At least one auto industry expert sees only positives for auto dealers. In fact, Greg Goebel, CEO of industry consultant DealerStrong, says that though financed auto transactions in the subprime segment fell lower as a percentage of all deals than at any time since the Great Recession, it’s now increasing. 

The recent spike in new-vehicle trade-ins in negative equity largely doesn’t apply to the subprime segment, he said, because those consumers make up a small fraction of new-vehicle sales due to the high payments and the fact that auto lenders typically prefer to finance used vehicles.

Meanwhile, many subprime segment consumers have caught up on what they owe, auto interests rates have fallen slightly, and some auto lenders have eased their credit thresholds, he said.

Experian said that due to the interest rate declines, auto loan refinances jumped 70% year-over-year in the second quarter.

“That means it’s time for dealers to refocus on this segment, especially in the used-vehicle market,” Goebel said.

To do that, he advises dealers to know their customer bases’ credit profiles and align those with their stores’ used-vehicle inventories and finance partners’ deal parameters.

“Vehicles need to be purchased, reconditioned and priced so that they are retail-ready with a cost basis below the average trade value in the book your finance companies use,” Goebel said. “Most importantly, deals must be structured so that all three parties—the customer, the finance company, and the dealership—come out ahead. That requires focusing on affordability.”

The national breakdown of auto dealers’ showroom traffic is 67% prime to near-prime and 33% subprime to deep subprime, Goebel said, though individual stores’ splits can vary widely.