Spitzer Ford sales manager Jerry Randall has a way to lower customers' monthly payments to boost car sales: stretch the loans over six years.
"People love them, they really sell more cars," said Randall, whose sales rose 7 percent last month at his dealership in Cuyahoga Falls, Ohio. Monthly payments on a US$24,000 Ford Taurus are US$352.95 with a six-year loan at 1.9 percent interest, less than the US$400 for five-year financing with no interest.
That draws buyers who typically can't afford a new car, he said. Ford Motor Co is the lender, so Randall isn't losing money when more of those buyers default. And they do, figures show.
Ford, General Motors Corp and DaimlerChrysler AG's Chrysler unit are extending more of their loans to six years rather than five, and taking on a greater default risk. They're trying to avoid losing sales to overseas makers such as Toyota Motor Corp and Honda Motor Co.
Car buyers are more than twice as likely to default on a six- year loan than on five-year financing because these less-affluent borrowers may run short on cash. Automakers earn as much as US$3,300 less on each car they sell at 1.9 percent interest than they would with rates of about 6 percent charged by banks, Comerica Bank Chief Economist David Littman said.
"They're doing a financial juggling act," said Lynn Yturri, a fund manager for Banc One Investment Advisors, which owns 100,000 preferred General Motors shares and sold 100,000 Ford shares in December. "Every time we look at these stocks we come up with another big problem. I'm looking to get out of my General Motors shares."
US automakers pay so much more for such fixed costs as pensions, health-care coverage and factories than overseas rivals that it's cheaper to keep making cars when demand slows rather than shut plants, analysts said.
General Motors spends US$842 on pensions for every car built in North America, for example, more than US$100 at Toyota, said Morgan Stanley analyst Stephen Girsky.
General Motors stock fell 39 percent in the year through Feb. 25, while Ford slid 47 percent and DaimlerChrysler's US shares declined 24 percent as US automakers lost market share to overseas rivals. Those declines were larger than the 4 percent slide in Honda's American depositary receipts and an 8.7 percent drop in Toyota's ADRs.
Borrowers end up paying more for the lower monthly costs by the end of the loan. A Taurus buyer with six-year financing pays US$1,412.96 in interest over the life of the loan, while some five-year loans have no interest charges.
About 5.6 percent of buyers don't repay 72-month loans, more than twice the 2.1 percent who default on 60-month loans, said CNW Marketing/Research, a company that studies consumer borrowing. The number of six-year loans will rise to 300,000 within three years from 34,000 in 2001, CNW estimates.
The portion of all Ford loans that span six years has more than doubled to 15 percent from 7 percent in the third quarter of 2002 as rebates and no-interest financing with shorter durations lost their allure for US buyers, said the Power Information Network auto data company. Automakers began offering interest-free loans to draw customers back into showrooms after the Sept. 11 attacks, more than 17 months ago.
The more automakers use the six-year loans, the better their sales. Ford offered 72-month loans on 19 models in January and its US sales rose 4.1 percent last month. General Motors used the loans from its General Motors Acceptance Corp unit on just six models and sales fell 2 percent, while Chrysler had such loans on two models and sold 12 percent fewer autos.
Toyota didn't use six-year loans, and its US sales fell 5.7 percent in January. Honda sales rose 6 percent because the company added the Element and Pilot sport-utility vehicles and a redesigned Honda Accord to its product line. US automakers' share of domestic sales slid to 59.1 percent in January from 59.2 percent in the year-earlier month.
The strategy of propping up sales with six-year loans will backfire on US automakers, said Tony Plath, a banking professor at the University of North Carolina in Charlotte.
"We hear about predatory lending. Well, this is going to encourage predatory borrowing," Plath said "People will just walk away with a free car and stop paying."
Ford and General Motors plan to use more asset-backed securities, bonds backed by collateral of auto loans, to raise money this year for their business because that borrowing is less expensive than unsecured corporate bonds. Adding 72-month loans to the collateral of asset-backed bonds will force automakers to pay investors a higher yield, said Anthony Thompson, managing director and head of US asset-backed research at Deutsche Bank.
"It's probably US$10,000 more on a US$100 million bond," he said. "That starts to add up when you're talking about a very big deal."
Automakers began offering the six-year loans to compete with banks. Bank One Corp and Bank of America Corp are already writing about 40 percent of their auto loans at 72 months and Wells Fargo was as high as 79 percent in 2002, Ford spokesman Jim Cain said, citing Power Information Network figures. Interest on six-year loans from a car company range from 1.9 percent to 4.9 percent, lower than the 6 percent to 10 percent at banks.
The higher default risk and costs will pay off by drawing new buyers who may otherwise have been able to afford only used cars, said Mark Norman, Chrysler vice president of sales and marketing.
Automakers are betting buyers with six-year loans will trade in their cars before the loan is up, limiting the costs for car companies, he said.
"We can manage the risk and still get more buyers," Norman said. "I'd rather be marketing to my own customer than having them get the loan from a bank."
Automakers charge lower interest rates than banks do on six- year loans. Wells Fargo & Co, for example, charges a customer with a good credit history 6.09 percent interest on a 72-month loan, according to the bank's Web site.
The 1.9 percent loan on a Taurus would yield US$1,412.96 in interest in six years, while the same loan at 6.09 percent would earn US$4,711.42. Ford pays the difference between its cost to borrow money for loans and revenue from 1.9 percent interest as a marketing expense, Cain said. "Every vehicle that's financed at 72 months by someone else is a lost opportunity," he said.
General Motors agrees. The world's biggest automaker uses the loans on its least expensive models as "a market-expanding move," said John Smith, group vice president of sales, marketing and service.
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