Extended Loan Terms and Auto Loan Default Risk

A salient feature of the $1.2 trillion auto-loan market is the extension of loan maturity terms in recent years. Using a large, national sample of auto loans from the entire auto market, we find that the default rates on six- and seven-year loans are multiple times that of shorter five-year term loans. Most of the default risk difference is due to borrower risks associated with longer-term loans, as those longer-term auto borrowers are more credit and liquidity constrained. We also find borrowers’ loan-term choice to be endogenous and that the endogeneity bias is substantial in conventional default model estimates. To mitigate this risk, we separately estimate instrumental variable regression and simultaneous equation models. Finally, we find evidence of adverse selection in borrowers’ loan-term choices in the years when six- and seven-year loans first became widely used, which dissipates over time as lenders adjust to risks in the market.