As we step into 2025, vehicle affordability remains a significant challenge for consumers and financial institutions. Negative equity — when a borrower owes more on their auto loan than the vehicle’s current value — has become increasingly prevalent, exacerbated by the high vehicle prices that dominated the post-pandemic market.
For lenders, addressing negative in credit union auto lending requires a comprehensive understanding of its causes and trying a different method to the usual strategy of extending loan terms to achieve affordable payments — an approach that ultimately makes the problem worse.
The Impact Of Post-Pandemic Vehicle Prices
The automotive market underwent substantial disruptions during the post-pandemic period. Supply chain issues and increased demand led to elevated prices for both new and used vehicles. Although prices have begun to stabilize, they remain high compared to pre-pandemic levels. According to Cox Automotive, the average new vehicle price is approximately $49,000 as of late 2024, down from $50,300 in June 2023 but still significantly higher than in early 2021.
These inflated prices have contributed to a rise in negative equity among consumers. Data from Edmunds indicates that in the fourth quarter of 2024, 24.9% of trade-ins toward new-car purchases had negative equity, up from 20.4% in the same period in 2023. The average amount owed on upside-down loans reached an all-time high of $6,838, surpassing the previous quarter’s record of $6,458.2
Consequences For Borrowers And Credit Unions
For borrowers, negative equity limits financial flexibility, making it challenging to trade in or sell vehicles without incurring losses. This situation is particularly problematic when vehicles are totaled, as insurance payouts might not cover the remaining loan balance, leaving borrowers without GAP insurance responsible for the deficit. 3
For credit union auto lending programs, the implications include:
- Increased Default Risk: Borrowers with negative equity are more likely to default, especially if they face financial hardships.
- Strained Lending Portfolios: High levels of negative equity can limit borrowers’ ability to qualify for new loans, affecting portfolio growth.
- Repossession Challenges: In cases of default, vehicles with significant negative equity yield lower recovery values, leading to greater losses for the credit union.
Residual-Based Financing: A Strategic Solution
To address these challenges, residual-based financing offers a practical solution. This approach allows borrowers to have lower monthly payments and reduces the risk of negative equity, benefiting both members and credit unions.
How Residual-Based Financing Works
With residual based financing, the monthly payment is based on the vehicle’s depreciation over the term rather than its entire purchase price. Financing is structured with a residual value — the projected worth of the vehicle at the end of the term — around which the monthly payments are calculated. At the end of the term, borrowers have options to sell, turn the vehicle in and walk away, purchase it at the residual value, refinance it, or trade it in for a new one.
Benefits Tor Borrowers
- Lower Monthly Payments: By making payments only on the projected depreciation, members can afford vehicles without overextending their budgets.
- Reduced Negative Equity Risk: Shorter terms decrease the likelihood of borrowers owing more than their vehicles are worth. Programs with a “walk-away option” at the end of the term can help fully eliminate negative equity.
- Flexibility At Term-End: Borrowers have multiple options at the end of the term, allowing them to choose what best suits their financial situation.
Benefits For Credit Unions
- Enhanced Loan Affordability: Lower payments make loans more accessible, helping your credit union retain your existing members who won’t have to look for other more affordable financing options. You additionally attract a broader member base, which drives portfolio growth.
- Reduced Default Risk: With a lower chance of negative equity, the risk of default diminishes, leading to more stable lending portfolios.
- Improved Member Loyalty: Residual-based programs encourage repeat business as borrowers return for new loans at the end of their terms.
Implementing Residual-Based Financing
For credit union lenders considering this approach, the following steps are recommended:
- Educate Members: Promote your program through all your marketing channels to raise awareness and clearly communicate the benefits and structure of residual based financing to ensure members know and understand their options.
- Train Staff: Equip lending teams with the knowledge to explain and implement residual-based loans effectively.
- Leverage Technology: Use tools to accurately calculate residual values and manage end-of-term processes seamlessly.
- Partner Strategically: Collaborate with experienced providers to implement a proven residual-based financing program that aligns with member needs.
Looking Ahead
In 2025, vehicle affordability and negative equity continue to pose challenges for consumers and financial institutions. By adopting innovative solutions like residual-based financing, credit union auto lending programs can offer members more manageable payment options, reduce financial risks, and strengthen member relationships. Proactively addressing these issues will position credit unions as leaders in providing flexible and responsible financial solutions in a dynamic automotive market.
Want to learn more? Register for Auto Financial Group’s residual-based financing webinar today.
Tim Kelly is the president at Auto Financial Group and has more than 25 years’ experience delivering solutions to financial institutions. Reach him at tkelly@autofinancialgroup.com.
Auto Financial Group (AFG), a Houston-based company, provides an online, residual-based, walk-away vehicle financing product called AFG Balloon Lending, as well as vehicle leasing and vehicle remarketing to financial institutions across the United States. For more information about AFG call toll free at 877-354-4234 or visit www.autofinancialgroup.com.
