Why Aren’t Aircraft Rates More Like Auto and Mortgage Rates?

©2020 Adam Meredith

 

The key to understanding why aircraft loan interest rates are not comparable to auto loan rates is understanding two components of lending: residual value and interest rate income.

For purposes of this discussion, residual value is the value of an asset at some future point in time. Residual values are impacted by a number of factors. Certain brands and models fare better than others but the question is why? Aside from quality, brand, and price points, one of the biggest determinants of volatility is the number of units that exist. In this case, "volatility" is defined as a low confidence in predictability. Generally speaking, the more units of an asset that exist, the higher degree of confidence one can have in predicting that asset’s value in the
secondary market.

Every year, millions of automobiles are manufactured, creating a large and efficient secondary market of even more millions. As a result, there are numerous transactional data points providing strong confidence in forecasting residual values.

The aircraft market is much smaller than the auto market. One reason for that was the cessation of general aviation manufacturing in the mid-1980s due to excessive product liability lawsuits. While the General Aviation Revitalization Act of 1994 served to remedy the problem, general aviation piston, turboprop and jet aircraft are still not produced in the prodigious numbers that automobiles are. Also, the size of the aircraft market is small in large part due to the small number of active licensed pilots compared to the number of active licensed drivers.

On top of all that, the market for used aircraft is much more influenced by externalities like price of aviation fuel and the status of the overall economy when compared to the market for cars. These market influences make the secondary aircraft market less stable, therefore making the ability to maintain consistent residual valuation more volatile.

Finally, there is the matter of the cost of money. This cannot be underestimated. For a lender, the way to recoup that cost is by charging  interest on the loan. If bank revenue is a product of interest rate times loan amount times time, then there are four ways to potentially profit on loans: increase the loan amount, increase the length of the loan, increase the number of loans, or increase the interest rate.

Beware of lenders advertising interest rates as low as those currently available for home mortgages. The reality is those low rates tend to be for larger loans above $250K that or loans that have a shorter term with a balloon, or loans where rates are floating. The amount of work to underwrite and document an aircraft loan under $100K is not much different than one for $1MM. As a result, the real costs associated with originating a loan are proportionately much higher and thus there’s diminished ability to offer lower rates. Bottom line is whether it’s for aircraft, boats, or anything else, expect low-dollar loans to come with a higher interest rate.

Great advice. Great rates. From helpful and responsive reps you can trust. Three good reasons to turn to AOPA Aviation Finance when you are buying or refinancing an airplane. If you need a dependable source of financing with people who are on your side, just call 800.62.PLANE (800.627.5263).

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