Yesterday, the Consumer Financial Protection Bureau (CFPB or Bureau) released a report on the state of negative equity in auto lending. The CFPB says it found that financing negative equity creates increased risks for consumers, and states that the CFPB will be putting negative equity under scrutiny.

This report, the first in a series, utilizes data from the CFPB’s Auto Finance Data Pilot, launched in February 2023. The CFPB’s stated aim with the Auto Finance Data Pilot is to examine trends in the auto industry that may create risks for consumers.

Negative equity occurs when the trade-in value of a consumer’s vehicle is less than the outstanding loan balance, and the unpaid balance is rolled into a new loan. A report cited by the CFPB indicates that in the fourth quarter of 2023, 20% of vehicles traded in were in a negative equity position, an increase from a low point in the first part of 2022. While several factors contributed to this, a significant factor is that used car prices fell from their peak in 2022. This led to a more rapid depreciation trajectory than normal for consumers who purchased vehicles at the top of the market.

According to the CFPB, this practice can place consumers in a precarious financial position, increasing the risk of default and repossession. The CFPB’s report highlights several findings:

• Prevalence of Negative Equity: Over 10% of borrowers financed negative equity from a prior vehicle loan into a new loan. Between 2018 and 2022, 11.6% of all vehicle loans in the dataset included negative equity, with the percentage peaking at over 17% in 2020.
• Increased Risk of Repossession: Consumers who financed negative equity were more than twice as likely to have their account assigned to repossession within two years compared to those with positive trade-in balances.
• Higher Loan Amounts and Payments: Loans with negative equity had larger amounts financed and higher monthly payments. The average loan amount for these accounts was $32,316 (compared to $28,244 for accounts with a positive trade in balance), resulting in an average monthly payment of $626 (compared to $493).
• Demographic Disparities: Consumers who financed negative equity typically had lower credit scores, lower household incomes, longer loan terms, and were more likely to have a co-borrower.
• Higher Loan-to-Value and Payment-to-Income Ratios: The average loan-to-value (LTV) ratio for accounts with negative equity was 119.3%, significantly higher than for those with positive trade-ins (88.9%). Similarly, the payment-to-income (PTI) ratio was higher (9.8% for negative equity compared to 7.7% with positive equity), indicating a greater financial burden on these consumers.
• Impact on Less Expensive Vehicles: Nearly a quarter of consumers financing less expensive vehicles included negative equity in their loans, compared to 16% for more expensive vehicles. In 2020, nearly 25% of consumers who purchased new vehicles in the $20,000-$29,999 price range financed negative equity, compared to 15.8% of consumers who purchased vehicles that cost more than $50,000. The percentage of negative equity relative to the vehicle price was also higher for less expensive vehicles.

The CFPB ominously concluded its report by stating that “with the understanding that consumer outcomes for those who financed negative equity seem to be worse than for those who did not, the CFPB will more closely examine the data on and lender use of this practice.”

Our Take:

We were a bit surprised that negative equity was the focus of this first CFPB report using the data from last year’s 1022 orders. The “conclusions” stated by the CFPB all seem relatively obvious (i.e., if you have negative equity, your amount financed will be higher, your LTV and PTI ratios will be higher, and your monthly payments will be higher). And it is unclear what the CFPB might do about the existence of auto purchases that include negative equity from a prior vehicle, since there is no readily apparent authority for the Bureau to rely on, nor any steps the CFPB could take, especially given its lack of jurisdiction over auto dealers. We will stay tuned and see what the Bureau may have in mind on this issue.