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Consumers’ trend toward used cars, especially certified pre-owned, could eventually slow the growth in sales of extended service contracts, says Mike Buckingham, senior director of J.D. Power and Associates’ automotive finance practice.
Indeed, service contract penetration is slowing among prime-risk borrowers, which Buckingham links to purchases of certified pre-owned vehicles. Those vehicles come with a factory warranty.
“There are some attractive certified 2- or 3-year-old cars out there, with low interest rates and a low price point, which dealers are telling me is causing some people to switch” from new to used, Buckingham told Automotive News.
U.S. certified pre-owned sales this year through July totaled 1.6 million, up 4.1 percent from the first seven months of 2015, according to the Automotive News Data Center.
The popularity of leasing, which reached an all-time high of 36.4 percent of new-vehicle financing in the second quarter of 2016, according to Experian Automotive, also could crimp service contract sales. Lease customers buy fewer service contracts because they usually turn in their cars before the original warranty expires.
Buckingham said the net result is a cloudier outlook for extended service contract sales, although he cautioned that sales are unlikely to decline outright.
Narrower gap
Changes in service contract penetration for new vehicles vs. used are apparent over time, with new vehicles showing a much bigger increase in penetration.
This year through July, among prime-risk borrowers, extended service contract penetration for new vehicles was 50.8 percent, compared with 49 percent for all of 2015. For used vehicles, it was 51.3 percent, up from 50 percent, according to the Power Information Network.
In 2007, though, service contract penetration for prime-risk borrowers was 39.3 percent for new vehicles and 46.3 percent for used. Since then, the “gap has shrunk considerably,” Buckingham said.
New-car service contract penetration increased 11.5 percentage points for prime-risk borrowers since 2007, while used penetration increased just 5.1 percentage points. The gap between new- and used-car penetration shrank from about 7 percentage points in 2007 to just 0.5 percentage points this year through July 26, he said.
Move to used
At the same time, used vehicles are gaining share among prime-risk borrowers, Experian Automotive data show. According to Experian, 60 percent of prime-risk borrowers who got an auto loan in the second quarter of 2016 got a used-vehicle loan, a 6.6 percent increase from a year earlier. And superprime borrowers are latching onto used vehicles at an even higher rate: 43.3 percent chose a used-vehicle loan in the second quarter, up 10 percent from the 2015 period.
Experian defines prime-risk borrowers as those with credit scores of 661-780 and superprime borrowers as those with scores of 781-850.
Melinda Zabritski, senior director of automotive finance for Experian Automotive, said that in response to higher sticker prices, consumers are turning to leases, longer loan terms — and used cars — to keep monthly payments low. “A lot of it speaks to affordability,” she said.
The outlook isn’t entirely bad for extended-service contracts; it’s just not as rosy as before, said Buckingham of J.D. Power.
Positives for extended-service contract penetration include longer loan terms and the fact that dealerships are trying harder to sell service contracts and other F&I products to make up for thinner margins on new and used cars, he said.
“If you think about it,” Buckingham said, “the customers that are financing cars now are financing them for a lot longer.”
Add the increasing F&I focus at dealerships to “consumers with those long loan terms and complex cars that are more costly to fix if something breaks,” Buckingham said, and service contract penetration is unlikely to decline.
Hannah Lutz contributed to this report.
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