Rebates and Incentives Have Led to Bloated Negative Equity Auto Loans

It first occurred at halftime of the Super Bowl on January 12, 1975. Sportscaster Joe Garagiola started hawking for Chrysler with the famous slogan, "Buy a car, get a check!" Buyers were promised a $200 rebate check when they bought a new Chrysler. Chrysler was doing anything they could to move metal and keep their factories producing.

I won’t regurgitate history, as readers know that rebates and incentives have been part of the retail landscape ever since. I remember thinking in my own stores, “How and when can it end?” during the last big retail downturn – from early 1989 to early 1991 – when rebates on new vehicles hit the unheard-of $1,000 per car, then $1,500 per car. I knew then it was becoming the “juice” and sooner or later it all had to come to a painful end.

You see, it didn’t take long to know that the consumers weren’t standing by their mailbox waiting for their checks. Dealers started using it as equity in the deal. A new Chevrolet Impala had an MSRP of around $4,000 in 1980. Back then, $200 was five percent of the purchase price and the average term was not even 36 months. For creditworthy customers (there were a lot more of them back then), $200 might be a sufficient down payment. If not, it was a great start.

Scroll forward to 2008. Since I no longer am a dealer, I don’t see the messages as they come in via the DMS or e-mail, but I know what I read and see on TV. Recently, I have seen $8,000-plus incentives being offered, and of course, Dodge has offered Rams at 40 percent off MSRP. The “juice” just keeps getting stronger and even more necessary to unwind consumers who now average $4,221 in negative equity.

Dealers say consumer credit doesn’t exist. Certainly, some banks and finance companies have perished. Others have merged, while others have had their access to capital greatly reduced. Guess what? To create revenue banks still have to loan money. Credit is still available, even to subprime credit customers. The difference is that after gas prices spiked and collections fell, repossessions occurred. Deficiency balances ballooned after the wholesale prices on SUVs and large pickups plunged. Between that and a manufacturer advertising 40 percent off of MSRP, it suddenly dawned on those making loans that maybe they weren’t in a strong enough equity position.

As a result, most of the largest banks and finance companies have now modified their credit models and reduced their advances. Prime credit customers carrying negative equity are now being asked to put skin in the game. These are customers who previously have been buying by simply rolling their negative equity into the next loan. That practice is no more.

The same thing has happened on the subprime side. Most finance companies have reduced their advances and raised their required down payments back to where they were 15 years ago and are still not comfortable, as wholesale prices continue to fall on used vehicles and the retail sales slowdown causes demand for those vehicles to fall and dealer inventories to bloat.

The bubble has burst. It is obvious that larger rebates or incentives are no longer the answer as some finance sources are beginning to put caps on how much of a rebate or incentive can be used as cash down. Additionally, the public has proven that at some point, these incentives no longer matter; new vehicle sales have tanked even in the light of unprecedented offers.

What is the answer? Unfortunately, a big part of it is time. It takes time for people to build equity in their vehicles. Someone $4,221 underwater in their car doesn’t get back to zero overnight. This is a bubble that has been building for many years, much longer than what created the real estate bubble. It is a bubble that will erase itself quicker than the real estate mess, but a bubble that must be absorbed nonetheless. A dealer can’t blame a bank or finance company for wanting to be more secure in their position, especially in these economic times.

The other part of the equation is money. Consumers must come to the realization that like many years ago, even the prime credit customers are going to have to come to the table with down payments. The good news for SF dealers is that subprime customers have been used to that. It was only in very recent years that finance companies had gotten to the point where someone with even a low-to-mid 500 credit score could buy a car with no money down (legitimately). These customers should be able to return to the fold much quicker, especially since the terms of their loans were shorter than prime credit customers.

I have been predicting for months that the “bottom” of the market would be between Thanksgiving and the end of the year. My only disclaimer (remember, I was a dealer and wrote ads for years) was that if one of the Big 3 files bankruptcy, or if we have January weather that is abnormally harsh, the dip may be extended. As I write this, it is in the middle of December and I have spoken to some of the top SF dealers in the country. Their business appears to have plateaued at the bottom. If I am correct, as the tax checks start to arrive in January and February, consumers who need money to create equity will have it and will start to spend it.

Don’t expect an overnight change, but the same basic fundamentals still are working. Also, as I predicted, many dealers have mistakenly bailed out of SF, or worse, shut their doors. That simply means that even if the market ramps back up slowly, the dealers capitalizing on SF will see more volume as there are fewer dealers doing business. Expect 2009 to be a reverse image of 2008, with more and more people able to buy as they begin to reduce their negative equity. Assuming that is the case, dealers still capitalizing on the SF market will see a steady but continuous increase in sales throughout the 2009 model year. Let’s hope my accuracy is still on target.

Until next month,
Better selling!

Vol 6, Issue 1