The U.S. auto industry, which keep setting sales records, is a real bright spot in the otherwise murky U.S. economy. But there are increasing worries that it’s been supercharged by risky loans to consumers with poor credit. New data released this week shows that growth in sales, and the size of loans, show no signs of slowing down— but there are hints that a growing number of low-credit consumers are having trouble making payments.
For at least a year, observers inside and outside the auto industry have argued over whether it’s fair to compare today’s subprime auto loan practices to the lending during the housing bubble that helped cause the Great Recession. But it’s now clear that such loans are critically important to the auto industry’s recent success, and a pullback of low-credit loans could lead to a domino effect that would impact the entire country.
Auto loans surpassed $1 trillion last year — higher than the total outstanding balance on all American credit cards — according to TransUnion. And the size of individual car loans continues to balloon. Experian reported this week that the average amount financed for a new vehicle at the end of last year was $29,551 – a record, and up $1,170 from the end of 2014.
Growth in the subprime market is helping lead the way. Experian Automotive reported last month that poor credit consumers now make up a record 20.8% of the new auto loan market — more than one in five new auto loans are going to subprime or so-called deep subprime borrowers. Because of their higher interest rates, often more than double what prime borrowers pay, subprime loans can be far more profitable for lenders. Average rates for subprime loans were 10.36% in the fourth quarter of 2015; for deep-subprime borrowers, rates averaged 13.31%, said Experian. At the same time, new car buyers with excellent credit paid 2.7% interest.
Shades of the Housing Crisis?
As with housing loans, auto loans are bundled together and sold off as bonds to investors. Last week, Fitch Ratings reported that delinquencies on subprime borrowers – consumers who are more than 60 days behind on payments — in those bonds have reached their highest rate (4.98%) since the recession. Annualized net losses are expected to rise close to 10% for 2016, Fitch said.
“Weaker performance in the subprime sector is being driven mainly by the weaker credit quality present in the 2013-2015 securitized pools, along with marginally lower used vehicle values,” the firm said on its website.
And that’s a mouthful — particularly the note about lower used car prices.
Subprime auto loans have some things in common with the kinds of subprime mortgages that got a bad name during the recession. They are packaged by originators and sold off to investors to pool risk and free up more money for lending, for example. But auto loans have critical differences, too. Many banks and bondholders left holding the paperwork when homebuyers defaulted found they had nearly worthless assets; entire neighborhoods or empty homes were hard to sell. On the other hand, it’s much easier to repossess a car than foreclose on a home. And there’s a thriving marketplace for used, repossessed cars, so lenders can recoup some or nearly all of the unpaid loan balance. For now, anyway.
Large-scale defaults on auto loans would flood the used car market, dragging down prices. That would also put pressure on new car sales, as prices for late-model used cars might attract some buyers to pass up new cars.
Experian said delinquent payments are a mixed picture, however. In its February report, the firm said that 30-day delinquencies were actually down across the board, pushing the overall rate to 2.57% from 2.62% a year ago.
On the other hand, 60-day delinquencies grew from 0.72% to 0.77%.
“While rates in the more severe delinquency category are up, it’s important to note that the increases are modest and relatively low from a historical perspective,” Melinda Zabritski, senior director of automotive finance for Experian, said in a press release. “Also, given that we’ve seen an increase in loans to subprime and deep-subprime consumers, it’s natural to see a slight uptick.”
The problem of potentially risky car loans attracted a lot of attention last year, when a series of state and local regulators — including the Securities and Exchange Commission — announced they were opening up inquiries into the market.
“Studies show that subprime loans, which have been blamed for the country’s mortgage crisis, are growing at a staggering rate of more than 130% since the financial crisis,” said New York’s Department of Consumer Affairs Commissioner Julie Menin last year when announcing that office’s probe. “For many families, especially those with low incomes, a car is one of the biggest purchases they make and if they are looking to a subprime loan, it’s because they are already struggling financially.”
The new popularity of so-called longer-term auto loans — stretching out as long as 84 months – also concerned regulators. Experian said this week that longer-term loans now make up 29% of the new car sales market. While longer terms lower monthly payments, they also raise the possibility that consumers burdened by them are deeply underwater in their car loans, owing far more than the value of their cars. The average new subprime auto loan is now six years, or 72 months, and carries an interest rate of more than 10%, according to Experian.
Recent scrutiny has brought about some changes. Wells Fargo announced last year it would cap subprime auto loans at 10% of its business, for example. But overall, the subprime auto loan market keeps growing — up from 20.3% of all loans in the fourth quarter of 2014 to 20.8% in the fourth quarter of 2015. TransUnion said in November that total outstanding subprime auto loans now stand at $154 billion.
Fitch, which garnered attention with its report about subprime loan “elevated losses” last week, is not exactly ringing the alarm bell.
“The peak subprime (loss) rate was 13% recorded in early 2009 at the height of the financial crisis, so current losses are well below this level,” it said. “Net losses … are rising marginally, but remain well within Fitch’s expectations.”
Still, the recent rise in serious 60-day delinquencies has the attention of the industry, and it should get the attention of anyone with a stake in the U.S. economy.
“Although not yet a cause for concern, the industry should keep an eye on this metric to see how it trends in the quarters to come,” Experian’s Zabritski said. “While loan balances continue to rise and funding may be more easily attainable, it is critically important for consumers to stay on top of their monthly payments to keep the automotive market running on all cylinders.”
Remember, if you’re thinking about buying a car, you may want to check your credit first, since a good credit score will help you qualify for better terms and conditions. (You can do so by viewing your credit scores for free each month on Credit.com.) If your score is in rough shape, you may be able to improve your score by disputing errors on your credit report, paying down big credit card balances and identifying other areas that may be holding you back.
More on Auto Loans:
- Are There Car Loans for People With Bad Credit?
- What to Do If You Can’t Make Your Car Payments
- Top 5 Worst Car Buying Mistakes