The Age-Old Concern
Many thoughts go through the mind of the potential vehicle buyer. Purchase criteria focus on the vehicle’s benefits and costs during the period of ownership, but the vehicle’s trade-in value often makes an appearance in a buyer's list of top 10 criteria.
Most buyers have a repurchase horizon of four to seven years, and hope that the vehicle will be the foundation of that next purchase. From the dealer perspective, a repurchase horizon of three to five years is a bit more appealing. So, any protection product that improves the likelihood and appeal of an accelerated trade-in cycle has real value to the dealer.
The Negative Equity Concern
Even if the current buyer arrives at the dealership without existing negative equity, almost every financing buyer faces some period of negative equity. New-vehicle buyers accept the substantial first-year depreciation, but a lurking concern is that the value of the vehicle will depreciate faster than the debt is being repaid.
Nothing squelches a buyer’s trade-in fantasies faster than the specter of negative equity. And then, there are the 30-plus percent of finance buyers who bring a fair chunk of negative equity to the current transaction and have a deeper hole to climb out of.
The importance of this concern is demonstrated every day by the high acceptance rates (30-plus percent) of GAP waiver protection (or GAP insurance). GAP was not on the F&I menu 10 years ago, but is now a staple of the F&I protection suite.
A total loss is just one form of trade-in. With GAP protection, the vehicle buyer has a chance to enter this involuntary trade-in process on an even keel. GAP takes care of the one percent of vehicle buyers who experience a total loss at a time of negative equity during a vehicle’s period of ownership.
A Different Triggering Event
How can we protect the other 99 percent of vehicle owners from negative equity at trade-in and build/make dealer loyalty in the process?
The traditional answer is a lease. It provides residual value protection at a specific point in time, such that the lessor knows that a “trade-in” can occur at a specific “trade-in” price. At the lease termination date, the lessor can close the lease with zero equity or purchase the vehicle at a stated price. Lessors' dealer loyalty is strong, but the terms of most leases are shorter than most new-vehicle buyers’ next purchase window.
Can we design a protection product that will eliminate any existing negative equity by defining the protection’s triggering event as the point when the owner is willing to purchase a new vehicle? Can we provide the protection over a wide trade-in time window, yet nudge the vehicle owner earlier in the trade-in cycle? Despite there being some terms and conditions on the protection, it is economically feasible with buyer-acceptable underwriting controls.
Two options are now available in the marketplace today:
- A complimentary protection product where the cost is absorbed by the dealer, lender or manufacturer (OEM).
- A voluntary product purchased by the vehicle buyer. Either option can be provided on specific vehicle make(s) or model(s).
The 2009 GM Total Confidence Program
For sales during April 2009, GM provided a complimentary protection product that made the following basic promise, subject to various other terms and conditions:IF you buy a new GM product during the sale period, excluding certain models … AND you finance your purchase under a conventional, fixed-term loan with a term of 72 months or less and a loan-to-value that does not exceed 110 percent AND you make at least 50 percent of your loan payments on time AND at least 50 percent of your loan term has passed AND you buy a new GM vehicle from a qualifying GM dealer, THEN the administrator-obligor will pay you the amount by which the balance of your trade-in vehicle loan exceeds the NADA clean retail value of your vehicle, up to $5,000.
In other words, GM (via the administrator-obligor) agreed to cover the buyer’s negative equity up to $5,000 if the buyer traded in the protected first-purchase GM vehicle on a new GM vehicle after more than one-half of the vehicle loan term had expired.
Trade-In Protection (TIP)
The concept is currently marketed by TradeCycle Management to OEMs, lenders and dealers on both a complimentary and optional basis. Its administrator-obligor is cynoSure. The administrator-obligor promises are backed by a commercial contractual liability insurance policy issued to cynoSure by Wesco Insurance Co., a member of the AmTrust insurance group.
As with any obligor program, the underlying protection product starts with a blank sheet of paper. The underlying promise, along with the various terms and conditions, can materially affect the cost of the protection.
The GM terms and conditions are certainly a good starting point. The underlying promise meets the buyer’s desire to have a viable trade-in opportunity during the buyer’s traditional trade-in cycle window while offering the dealer the opportunity after one-half the loan term has passed to initiate a next-purchase/trade-in call with an approach such as, “Good news, don’t forget that you are now eligible to trade in your existing vehicle now without worrying about negative equity.”
A complimentary program comparable to the GM program can be provided to the dealer for about $300 per vehicle, assuming the dealer (or OEM) places the protection on a “blanket basis.” An optional program’s dealer cost will be higher due to the lower volume of protected sales, and the retail cost to the consumer will include a dealer markup.
Lenders Can Do This, Too
If the current purchase is financed under a retail installment sales contract, an indirect lender could include a debt cancellation TIP loan addendum comparable to the dealer’s TIP promise; e.g., “if you return to this dealer, trade in this vehicle and that loan is “sold” to this indirect lender….” This is a bit of a stretch, but such a program is possible.
Alternatively, the promise could be an administrator-obligor promise. (A debt cancellation addendum is a lender-obligor promise to cancel part or all of a debt if the contractual conditions are met.)
A more viable approach is available to direct lenders, such as banks and credit unions that are not active in indirect lending. Here the promise becomes more straightforward: “if you return to us (the lender) to directly finance your replacement purchase….” This promise can also be a debt cancellation loan addendum or an administrator-obligor promise.
In either situation, the lender can insure its contractual promises under a commercial contractual liability insurance policy.