New studies show that while Americans took out fewer mortgages in the last decade, auto and student loan balances have largely replaced the decline. Since 2013, consumer debt rose by 12.8%, adding $22 billion in auto loans the last quarter of 2016.
The numbers themselves are not as troubling as the similarities to the housing crisis in 2007.The economic crash, leading to the recession, resulted in government bailouts of major companies within the auto and banking industries, massive job losses, record levels of foreclosures, and millions in lost investment returns. The recession was so severe experts compared it to the Great Depression. Many consumers have yet to fully recover.
Today, the auto industry, seeking to drive higher profit levels, is turning to many of the same strategies the mortgage industry used to overinflate housing prices just prior to the crash. A rapid rise in subprime loans, especially deep subprime, those with credit scores of 550 or lower has risen from 5.1% in 2010 to 32.5% in 2016.
Similarities to the Mortgage Crisis of 2007 and 2008
The housing crisisartificially inflated prices in the housing market. The subsequent housing crash, which began in late 2007, was one of the catalysts to the great recession. Compounding the problem was the lenders who packaged the toxic loans into investment securities, effectively hiding the increased risk from investors. These practices led to massive market losses when these practices came to light. Consumers, were left owning homes worth less than they owed. When default rates soared, foreclosures flooded the market, sinking values in some markets to decade lows.
Since 2010, subprime lending in the auto industry has risen from 5.1% of the overall loans originated to 32.5%, nearing a total of $1.2 trillion in outstanding balances. These numbers represent a 60% increase above the 3rd quarter borrowing seen in 2010 and nearly a fifth of total retail spending. With the auto industry driving economic growth, accounting for nearly 20% of overall consumer spending and 3% of GDP, sales significantly impact on the economy as a whole.
Today, rising default rates have reached 12%.Subprime lending is on the rise: Innovative technology has increased confidence among lenders to locate and retrieve vehicles from defunct loans, leading to looser lending policies. Banks can now remotely disable a vehicle when a consumer misses a payment, and have installed GPS devices make it easier to find cars when borrowers fail to pay, reducing lender risk of losing the asset. Lenders focused on the subprime market also require Gap insurance to ensure they receive the full loan balance in the event of an accident, even when the customer owes more than the car is worth.
To further lower the risk of loss, banks’ giving loans to borrowers with low credit scores charge high upfront fees and interest rates upwards of 20%, despite the fact that the vehicle offers collateral for the loan. Vulnerable borrowers in long-term loans, up to 84 months, are paying well over the value of the vehicle.
Rising car prices, combined with lower down payment requirements, have pushed the average loan to $28,000. An estimated 25% of outstanding loans and 20% of new loans come from subprime borrowers paying the highest fees and interest rates to gain access to a vehicle.
Economic Impact for the Auto Industry and the Economy
While the auto industry has a lower impact on the overall economy than the housing market, car sales do drive GDP and consumer confidence. A collapse in the auto industry could affect more than a million workers.A collapse in the auto industry will make noticeable waves if the financing arm of the auto industry reaches a similar fate as those offering mortgages in 2007.
Rapid increases in vehicle repossessions will not be the same economic catalyst as the housing crash. A repossessed car does not drag down vehicle values across the board, like multiple foreclosed homes do to a neighborhood.However, mass repossessions would flood the market with used vehicles, which could lower prices due to supply and demand. With more used cars, prices fall, and demand for new cars diminish. Lastly, auto finance companies convert a smaller percentage of auto loans into securities, lesseningthe effect on investor returns.
What Rising Auto Loan Balances Means for You
Easy financing allows virtually anyone with a steady income to obtain avehicle auto loan. However, easier lending practices do not always benefit consumers. Paying thousands of dollars in fees and an interest rate in the high teens is not a good deal. When lenders require extras such as a GPS or GAP insurance, the borrower covers those costs, adding to the price of the car. High interest and longer loan terms can have you paying almost double the actual sticker price of the vehicle. Both new and used car dealers have resources to get you into a car, but that is not always in your best interest.
Having poor credit is one of the key factors lenders consider when establishing the terms of an auto loan. Before you buy your next vehicle, take necessary steps to improve your credit score, and pay down debt to get your debt to income in line. Waiting could save you thousands of dollars in financing costs over the course of the loan.