By on April 5, 2013

March was the 5th straight month of a SAAR above 15 million vehicles.  Industry analysts have explained the strength of the market in a number of ways. The need to replace older vehicles is one (new car sales were hit hard during the recession as consumers held on to their vehicles for longer. This also caused used car prices to skyrocket, something TTAC has been documenting), while others have cited increasing fleet demand, and the desire to replace vehicles damaged in Hurricane Sandy.

But one factor that is just starting to get attention outside of TTAC is sub-prime financing. Sub-prime lending, which involves giving high-interest loans to customers with poor credit scores, is driving the SAAR in a big way, by letting buyers with poor credit purchase new cars. In turn, the sub-prime bubble is being driven by Wall Street, whose clients cannot get enough of financial instruments backed by sub-prime auto loans.

On the surface, it seems unbelievable. Unemployment is at 7.7 percent, and even higher according to some pundits. Taxes are going up, wages are stagnant, the economy hasn’t really recovered according to many. And yet auto sales – for many people, the second biggest purchase they’ll ever make – are on a hot streak, rebounding back close to pre-recession levels.

Sub-prime loans, defined as a loan given to anyone with a credit score under 660, are now bigger than ever. In Q2 of 2012, new car sub-prime loans accounted for a quarter of of all loans, while 56 percent of used car loans went to sub-prime buyers.There’s even a new category called “deep subprime”, for auto loans issued to buyers with credit scores below 600. These loans account for nearly 11 percent of all car loans, despite the fact that a 600 credit score is considered abysmal.

A recent Reuters report detailed the usual routine of a sub-prime loan; a borrower with a poor credit rating is approved for a loan, often carrying an exorbitant interest rate hovering around 20 percent. In the Reuters story, the buyer agreed to finance a $10,000 2007 Suzuki at 21.5% interest using a shotgun (valued at $700) as his down payment. The buyer, stretched thin by various debts, including the car loan, ended up declaring bankruptcy. Another report by the Los Angeles Times outlined how unscrupulous used car dealers would issue sub-prime loans, knowing that their customers would default, wait for them to default, and then repossess the car and re-sell it, repeating this process over and over again.

In addition to the decreasing credit scores of car buyers (The Motley Fool reports that the sub-prime buyer’s average credit score dropped 9 points in 2012 compared to 2011), monthly payments have stayed static, due to 77 percent of loans lasting for longer than 5 years. This tactic allows buyers to manage the same monthly payment but borrow a greater amount, and thus able to afford a more expensive car without feeling more of a hit to their pocketbook.

Extending loans to unqualified buyers wantonly would seem like a poor business practice on the surface, but the demand for sub-prime loans isn’t just coming from consumers. Wall Street is also playing an enormous part in the practice. According to the New York Times, growth in securities backed by auto loans has been enormous. In 2008, investors bought $2.17 billion in auto loan securities. In 2011, that figure exploded to $11.7 billion.

The rationale behind the massive growth in auto loan securities can be linked to the Federal Reserve’s policy of Quantitative Easing. QE, which involves buying bonds and Treasury Secuities en masse, has injected liquidity into the market and kept interest rates artificially low. This has allowed banks to charge near-record low interest rates on all car loans, while also reducing yields on traditionally safer investments like bonds. Sub-prime car loans, packaged and sold into securities, are seen as riskier, albeit with the potential for greater return. And with hedge funds and institutional clients looking for a greater return on their money, auto loan securities have become the instrument of choice for a number of entities – even Google is investing in these instruments, after being frustrated by low returns elsewhere.

And just like the 2008 mortgage crisis, these sub-prime auto loans are being packaged and sold as AAA rated bonds. As the Los Angeles Times reports, the number of loans packaged and sold as a securities is in the tens of thousands. The thinking goes that even if some of the loans are delinquent, there are plenty more that will make the security safe. And like sub-prime mortgages, the securitized auto loans are being divided up into tranches, with demand for the riskiest tranches being strongest.

Unfortunately for American consumers, the biggest players in sub-prime auto financing have significant ties to domestic auto makers. A report by Reuters names Santander, which is Chrysler’s auto financing outlet, and GM Financial as the two largest sub-prime auto lenders in the United States. Santander alone accounted for 53 percent of all sub-prime financing – and Santander’s expertise in the field was apparently one reason that Chrysler decided to partner with the Spanish bank.

While both Chrysler and GM use Ally Financial for their prime loans (which are issued to qualified buyers), GM has its own seperate sub-prime arm, known as GM Financial. In Q1 2012, some 93 percent of GM Financial’s loans were to sub-prime buyers, up from 87 percent in Q4 2010. During that same period, loans to the least qualified buyers – those with FICO scores under 540, were up 79 percent. GM Financial’s delinquent loans also rose by some $200 million in 2012, to $933 million – higher than Ford Toyota and Honda’s combined delinquencies.

The situation in auto-loan securities has eerie shades of the 2008 mortgage crisis across the board: the eager distribution of not just sub-prime loans, but “deep sub-prime” loans to borrowers with the worst credit ratings. The securitization of auto loans and the hunger for the riskiest tranches of these securities. And the “AAA” rating of even the most egregiously crappy securities.

In light of these factors, it’s worth reflecting on how much of an influence sub-prime auto loan securitization is having on the lofty heights being reached by the new car market. The last time America experienced the bursting of an asset bubble, auto makers were stuck with excess capacity and significant overcapacity. Combined with a sudden contraction in consumer credit, these factors nearly brought America’s auto makers to their knees.

The current situation is not directly comparable to the mortgage crisis of 2008, but bares too many parallels for us to ignore. It would be the ultimate irony if another systemic crisis occurred, due to securitizied auto loans. They very instruments used to by auto makers to help spur sales growth will have ended up crippling them yet again.

 

Get the latest TTAC e-Newsletter!

69 Comments on “How A New Generation Of Sub-Prime Auto Financing Could Cause Another Catastrophe...”


  • avatar
    seth1065

    Sub prime credit score under 600, deep sub prime is stated in story as under 600 , I assume there should be another number there not 600 right Derek ????

  • avatar
    Type57SC

    I think you’ve got a typo in your subprime/deep subprime definitions.

  • avatar
    AmeroGuy

    There’s a world of difference between this and the housing crisis, chief being people think of there house as an appreciating asset not a depreciating one like a car. So if the sub-prime auto bubble collapses there’s not billions in lost wealth. In fact few people outside the banking industry would care.

    • 0 avatar
      Type57SC

      That’s a good point. You don’t see people taking out a car loan on a car they won’t drive to speculatively flip it in 12 months. and in housing, you don’t see a lot of starter/interupter locks on the front door.

      • 0 avatar

        And its easy to repossess a car. And people know that, and they’ll continue to make payments on the car they need to get to work long after they’ve stopped paying the mortgage.

        And much of the scary sub-prime action is happening in the used car market, where there has always been plenty of scary sub-prime action.

        And GM Financial is a big sub-prime lender because GM bought a subprime lending specialist and used that business as the base for its own new captive financing operation.

        I think there’s less here than meets the eye, but I’ll do more digging and write something about it next week.

    • 0 avatar
      jmo

      Exactly!

    • 0 avatar
      icemilkcoffee

      Normally people defaulting on car loans would not be a problem. But the problematic part is the securitization of these car loans. They’ve packaged them as grade AAA bonds, by making some assumption about how the car buyers wouldn’t default en masse. Assumptions which could turn out to be wrong. And the buyers of the bonds may foolishly believe in the credit agencies ratings. Or foolishly believe that since their bond is insured by AIG, nothing bad is going to happen.

      • 0 avatar
        ClutchCarGo

        This. The issuance of synthetic collateralized debt obligations (CDOs) and credit default swaps against the sub-prime mortgages were the real reason that the economy crashed and burned in 2008, not the mortgage defaults themselves. If the Masters of the Universe start in on these kind of actions using the sub-prime auto loans as a basis for exotic instuments to sell back and forth we could see yet another economic freeze-up like 2008 where everyone becomes afraid to deal with everyone else because it’s unclear who has exposure to secret bets on the direction of these loans.

        • 0 avatar
          BrianL

          But car prices are not being propped up way beyond their actual value. People know that car values drop. Home values were not expected to drop, well, not by people investing in the mortgage backed securities. It is a very different market.

      • 0 avatar
        indi500fan

        So we just channel our inner John Paulson / Kyle Bass, short these suckers, and all drive off in our new Bugatti Veyrons next year?

  • avatar
    Type57SC

    The demand from wall street comes from the dramatic credit outperformance of auto credit vs mortgage and revolving (CCs). These ABS portfolio paid in the boom and the bust, so they are attracting attention.

    On GM Financial, I assume you know this, but it is worth stating for readers that it is really AmeriCredit, the company GM bought and changed the name to GM Financial, that is the reason GM Financial is so sub-prime. No one should compare their book to anothe captive as apples to apples. they are even deeper than Santander, which I think is the old Household Financial. Withouth that knowledge, it reads as if GM is taking crazy risks without any good reason.

  • avatar

    The whole thing seems quite frightening, but help me to understand how this is a bad thing for me…

    In the case of the housing bubble, people were thrown out of their homes and either went into a rental, into public housing or on the street. Many of us who bought our homes in the lead-up saw our houses’ value crash and tens of thousands of dollars (on paper at least) evaporate – although it only becomes an issue if we try to sell.

    In the case of cars, sub prime loan-ees will lose their vehicle and the car will go back on the used market which will drive up the number of cars and prices back down to where ordinary people can afford them again. People will be annoyed, the car companies who sold their subrpime loans will be scott-free and only the investors too blind to connect the dots with the previous debacle will be out (unless the government decides to put the taxpayer on the hook again).

    The way I see it, as long as my pension or grandma’s mutual fund avoids this stuff I should be OK.

    • 0 avatar

      Car sales are being driven up on the back of sub-prime loan growth. But if the loans go bad and the instruments fail, then credit won’t be available for a lot of buyers. Definitely not sub-prime, since it will be too risky, and there may be further contraction. This could mean that car makers are stuck with a 2008-style deadly cocktail of overcapacity and excess inventory. We all know what happened then.

      • 0 avatar
        sunridge place

        The high interest being charged more than covers the losses. Subprime is very profitable when done correctly.

      • 0 avatar
        BrianL

        I think that the people who try to be new with subprime (which is crazy) will then buy used with subprime. There will be a shark out there to make money off of it. Lots of subprime on used lots is done by the dealership. This might drive up prices of used cars and then make new car buying appeal to people with better credit.

        Overall, the whole article is a stretch. Sub-prime mortgages aren’t going anywhere. The value of the cars are not being overly inflated because of subprime lending. That is a key factor which you aren’t considering with the difference in the home lending crisis.

  • avatar
    Type57SC

    One last pile-on before i got back to my work, the statement “In 2008, investors bought $2.17 billion in auto loan securities. In 2011, that figure exploded to $11.7 billion” is a bit misleading. 2008 was the bottom for auto finance. in 2006, the subprime ABS market was $21B. So compared to car sales, it’s far from “exploded”

  • avatar
    28-Cars-Later

    “deep subprime”

    [insert gratuitous sex joke here]

  • avatar
    Lorenzo

    I’m not worried. There’s always been a sub-prime auto finance market, and a good business plan charges high enough interest to offset the cost of repo’s. That part of the market today is rather large from an historical perspective, but I try to look on the bright side. There will be work for detailers sprucing up the repo’s and the late model used car market will get a needed boost in inventory.

    It’s bad news for the people who lose their new cars, that they couldn’t afford in the first place, but they’ve probably done stupid stuff like that before – how do you think their credit scores got so low? I know people will say these folks need to be protected from themselves, and it’s a cruel thing to say, but it’s a truism: you can’t fix stupid.

  • avatar
    Acd

    It wasn’t the borrowers’ inability to pay that tanked sub-prime auto but the lack of access to additional funding for the sub-prime lenders in 2008 & 2009 when money dried up to just about everyone.

    GMAC went down because of Rescap which was their mortgage business, not auto lending. Car loans are generally a profitable business.

  • avatar
    DC Bruce

    This phenomenon actually illustrates one instance of where the Fed’s easy money policy is having the intended effect: stimulating consumption. There are lots of reasons this is not like the housing bubble, as others have pointed out:
    1. People thought of/think of homes as an “investment” that will grow in value, so easy credit had the effect of making homes more valuable (increasing demand), which created a self-feeding cycle. When the cycle ended, the people who had most recently purchased homes were the ones left holding the bag, with “underwater” loans. No one thinks of a car as an investment. Yes, the available of cheap money may have had a modest effect on the price of used cars; but since cars aren’t financed over 30 years (like homes), the size of the car payment is driven more by the price of the car than the price of the loan.

    2. Because of belief #1 (homes are an investment), lenders understated to themselves and others the credit risk they were assuming. So, a lot of credit was “mispriced” in that the price didn’t really reflect the risk of default. No one will make a similar mistake with cars. Everyone understands that the creditor who finances 100% of a new car purchase is carrying a huge risk for the first 18 months or so, because the value of the car is less than the balance of the loan. So, the loan can be priced to reflect the risk.

    Frankly, one the big picture side, money flowing into car loans gives me a lot less worry than cheap money flowing into housing loans. While it’s true that today, mortgage lending standards are much higher (and there is no more 100% financing) a lot of the “value” in the housing market right now is being supported by the availability of 3 percent mortgage money. Put rates closer to historic rates of 5 – 6 percent and those values are going to shrink in a lot of markets where there isn’t demographic pressure (which is just about everywhere but metro Washington DC).

    • 0 avatar

      For everyone claiming that this isn’t like the mortgage crisis, I agree. Which is why I did write, in the final paragraph “The current situation is not directly comparable to the mortgage crisis of 2008″

      • 0 avatar
        Type57SC

        Except that your full sentence goes on to say”, but bares too many parallels for us to ignore.”

        The concensus response is that this is post, from the title’s “Catastrophe” on down, is too much hyperbole, looking for the click-through. For one, I’m not looking to comment on this site, but I want it to be objective and well founded, so comment on threads like this. If you’ve got a hunch about something you don’t know about, or are looking for some eyeballs, just say your hunch and ask commentors what they think rather than making an argument. Sorry if this seems like harsh feedback, but it’s what I’d prefer.

        • 0 avatar

          I don’t think it’s harsh feedback and all, and the comments add value to all the articles, so thank you (and everyone else) for replying. But I think at this point you and I are arguing over semantics. There are parallels yes, but that’s not the same as saying it is the same as 2008.

          Where I do object is when you accuse me of “looking for the click-through”. Why would I spend hours putting this together, doing the research, writing and editing when I could just post something about THIS IS THE BREASTS THAT GOT MANGLED IN A BROWN WAGON COCAINE SEX CHANGE. I have skin in the game when I write an article. Writing a poorly thought out, poorly researched article only hurts me in the end. If I didn’t think it was worthwhile or an interesting topic, I would not have made the effort.

        • 0 avatar
          ClutchCarGo

          Not to mention that the proper word here is bears not bares. I’m just sayin’…

          • 0 avatar
            shaker

            You’re correct, but in an odd way, “bares” sort of works too (if bares = exposes)

          • 0 avatar
            Japanese Buick

            Speaking of the proper word, “creditor” is used in this article as if it meant the exact opposite of what it really means.

      • 0 avatar
        fincar1

        While car loans and mortgages are not directly comparable, I see that our President who doesn’t know anything about economics is making noises about how we need to make it easier for people to get loans to buy houses again. I suppose he’s remembering how his pals like Franklin Raines made a lot of money and not how so many people got screwed in the bursting of the housing bubble.

        • 0 avatar
          shaker

          With the total recalcitrance offered by Congress, I would say that our President is forced to make less-than-optimal Executive Orders to try to move the economy forward.

  • avatar
    Sky_Render

    “I bought this car that I can’t afford the payments on. It’s the bank’s fault.”

    Does no one have personal responsibility anymore? Sure, you can argue that the banks are being predatory by handing out loans with interest rates of over 20%, but the people who sign the dotted lines are the ones making the decisions.

    • 0 avatar
      jkross22

      To answer your question, no, very few understand the idea that they are personally responsible for their own idiocy. It’s usually someone else’s fault.

      I’m amazed we’re still allowed to pump our own gas.

    • 0 avatar
      SomeGuy

      I’ve always been under the mindset that the poor and middle class will forever be damned to stay there thanks to things like bad car loans / buying new cars. As well as lottery tickets.

      You are right. No one is willing to say “It is my fault.”

  • avatar
    sunridge place

    ‘GM Financial’s delinquent loans also rose by some $200 million in 2012, to $933 million – higher than Ford Toyota and Honda’s combined delinquencies’

    This statement is only half correct. It is true that GM Financial’s delinquent loans rose by that much. It is also true that the % of their portfolio that is delinquent is higher than Ford/Toyota etc combined. The dollar amount is NOT higher than those three combined. Ford/Toyota/Honda/Hyundai etc all do plenty of subprime but their mix is that of prime/subprime so of course their delinquency % is lower.

    When GM’s agreement with Ally that requires a certain % of the prime business goes to their former captive group runs out soon, GM Financial will be able to balance their portfolio with more prime loans and leases and will normalize their numbers.

    If you were to just look at the delinquency of Ford/Toyota etc’s subprime group, I”m sure it would look the same. But, good luck getting that data from them. You’ll just get the overall portfolio %’s.

    One of the big un-reported stories is how the lack of a full captive lender has hurt GM’s overall financial performance since emerging from bankruptcy. They have made acquisitions globally to bring it back. Once they are totally free from Ally agreements in the US, GM will get the full financial benefit of a fully functional captive finance group. I doubt anyone realizes that, for example, when a GM dealer sells a GM Protection Plan extended warranty, the revenue from that extended warranty sale goes to Ally, not GM due to an agreement to let Ally market and sell the GM Branded extended warranty through a certain date (I think its 2014 or 2014) Warranties are insurance products formerly offered through GMAC and flowed to Ally and remain there today even with GM Branding.

    Take a look at how much Ford Credit and VW Financial contribute to the bottom lines of those companies versus GM Financial’s contribution to GM and you’ll be surprised. Not a bad story suggestion for TTAC to pursue.

  • avatar
    schmitt trigger

    “Does no one have personal responsibility anymore?”

    Sky, you are completely correct on this one. Having said that, in the consumer society the consumer’s mind is constantly manipulated to crave for more.
    This leads people to live beyond their means.

    But your original premise is ABSOLUTELY correct.

    • 0 avatar
      shaker

      If you watch Local TV news (especially in the morning), the 12 minutes of advertising out of every half-hour are largely car dealers touting crazy-low payments; much like propaganda techniques, it eventually sinks in. You start looking at that mostly-functional heap in the driveway and start dreaming of a new Camry (or whatever).

  • avatar
    icemilkcoffee

    People keep saying ‘but this is not like the mortgage crisis’. Well- you don’t know that. The mortgage crisis came to a head when the builders overbuilt and finally the whole housing market collapsed. Same thing could happen to the car market. GM might stupidly think that there is an endless supply of destitute people to buy their $30,000 Malibus. They pump out half a million of these Malibus. They end up having to cut the price to $15k. Now all the used car prices will plummet. People who previously bought $30k Malibus will default. The repossessed cars are worth a lot less than the banks had assumed. The bank begin to default on their bonds obligations. All the people who bought derivatives based on these bonds will also lose money. The insurer of the bonds will go bankrupt.
    So yes- it could happen.

    • 0 avatar
      Sky_Render

      The problem with your analogy is that no one is paying more for new cars than they are actually worth. At least, not yet.

    • 0 avatar
      ClutchCarGo

      Actually, the mortgage crisis came to a head when it was realized that the enormous number of synthetic CDOs and credit default swaps bought and sold by Wall St were underpinned by shaky mortgages. The mortgage defaults by themselves were a small fraction of the overall bets made by Wall St, and the uncertainty that resulted from all of those secret trades were what caused the freeze up.

    • 0 avatar
      BrianL

      If people are paying 30k for a car that is actually work 15k, then I would think there was something to this. But, they aren’t. They are paying what the cars are worth. With the housing markets, it wasn’t just too much inventory from new builders, but from houses that were bought and sold for far more than they were actually worth.

      • 0 avatar
        JD23

        How does one determine what cars are “worth”? If demand is being artificially inflated by easy lending policies, as was the housing market, how can you say that cars are not selling for more than their equilibrium price? I think there is a strong argument to be made that prices are inflated in the used market.

  • avatar
    CapVandal

    This is great news. We will never get the economy going without more spending.

    Quantitative Easing working exactly as intended.

    We gotta have the UP part of the business cycle. Otherwise you get a 1930′s style deflationary spiral.

    • 0 avatar
      Lorenzo

      Fed chairman Bernanke is an expert on the ’30s deflation, and he’s doing all he can to avoid it. Unfortunately, his zero-interest rates and clogging the Fed books with junk bond assets is producing what was called stagflation. Have you checked prices of pretty much everything lately?

      It’s the politicians who want the stimulus that doesn’t work, so they’re gone by the time the Stucco Hits The Fan. All assets must eventually be marked to market, and that means we’re delaying and making worse the heckalicious deflation that will result.

      • 0 avatar
        highdesertcat

        “Have you checked prices of pretty much everything lately?”

        Yep! That’s why so many people with money stashed away in safety-deposit boxes and under their mattresses, are pulling that money out now and buying stuff like second/third/fourth homes for cash money. That money will be worth even less tomorrow.

        Some people with money are even venturing into buying new cars, even though they are a depreciating asset and lose money the moment the car is driven off the lot. But at least they do have an intrinsic utilitarian value — transportation.

        Many old people with money would prefer to finance the purchase of a new car or truck and apply their cash-money to other purchases, but loans for old people still are not borrower-friendly.

        It never ceases to amaze me how lenders, subprime included, will find more ways to tack on additional charges like credit-life insurance, disability insurance and lender-issued car insurance that discriminate against old people, age 55 and older.

        Car loans for young people, subprime included, do not have such requirements because young people generally live long enough to pay off that loan, unless they default.

        Double standard here. Whatever happened to equality in lending? Or was there ever such a thing?

    • 0 avatar
      BrianL

      Not exactly. We may just be putting off the inevitable. But, QE is actually causing prices to rise on everything, which means you are getting payed less to do your job, even if the exact amount of cash you are bringing in doesn’t change. The inflation we are seeing isn’t good either.

  • avatar
    AMC_CJ

    Rather it be in the auto-world then real-estate.

    I walked into a Ford dealer with no credit history at all. I guess that would be sub-prime? Actually, according to the dealer, My case was even worse. Got the brand-new car I wanted at 3.9%apr 5-years. It came with a hefty down payment, but I had the cash (hence, never needing credit), but not that-much cash.

    I know more then a few people who have cars loans approaching the 20% loan rate, and making payments close to $400 a month, 5-years, for a $12,000 car due to credit issues…..

    But, I don’t see this as so much a bad thing. It’ll get more cars on the market, and if the buyer can’t pay, repossession is fairly easy. The only thing it hurts is the re-sale value of newer cars, but, we buy a car for the long run and by the time we’re done it won’t be worth much anyways. So, those people that trade in their cars every 2-3 years for a new one, rolling everything into a new loan and counting on the trade-in of their barely used vehicle might feel a small pinch, but for the rest of us. Hell, the only reason I bought a brand new car is because anything slightly used cost nearly as much, or in some cases, even more!

    • 0 avatar
      BrianL

      Paying 3.9% right now on a car isn’t good. Many places are doing less than 2% right now for 5 years. Having good credit is a must so that when you need it, you aren’t paying twice as much as people like me.

  • avatar
    CapVandal

    http://dealers.americredit.com/product-offerings/subprime-auto-loans.aspx

    The ‘typical ‘ GM Subprime borrower:

    Our subprime customer*
    Credit Bureau Score Range 500 – 800
    Average Annual Income $65 – $70 k
    Average Years at Present Employer 7
    Average Years of Credit History 13
    Homeowner 44%
    Average Loan Amount $21,300
    Average Down Payment 12%
    Average Term (months) 70
    Average Loan-to-Value (wholesale) 108%
    New/Used Collateral 51% / 49%
    Average Mileage at Origination 27,500 miles

  • avatar

    Wow it’s clear it is a hard time for everyone, but I feel like I’ve had just about enough of this sweeping under the rug or sub-par automotive finance. Sad world we live in. Great article thanks for shedding some light on a serious topic.

  • avatar
    Caboose

    What no one had talked about in all this (and really, no one talked about it during the housing/mortgage crisis, either) is the credit scores themselves.

    There is no neutral government agency that sets credit scores or sets parameters by which the scores are determined. One’s credit score is not built by “being a good citizen” or by “behaving responsibly”.

    It is the lenders, in concert with the three credit bureaus (who are also, guess what?, banks – big banks that own, or used to own, or started out as credit card banks) that set the scores. The lenders, including retail establishments, voluntarily report all you financial behavior to the credit bureaus, who aggregate, disaggregate, segregate, discriminate, profile, and feed into algorithm/meat grinder. Splat. Out pops your credit score.

    The scores started as a service provided by banks for banks. It is a measure of how good a customer you are. It is partly based on your own “responsible behavior”, defined not as, e.g.- keeping you debt-to-income reasonable, but rather as making your payments on time.

    The score is also based, however, on how profitable you are to the bank. So, ceteris paribus, the guy who pays off his Visa Platinum every month will have a lower score than the guy who carries a balance from which interest can be harvested.

    So if you are in debt up to your eyeballs, but make all your payments on time and carry a balance, the credit agencies will like you. Their reservations about your risk of future default are overcome by the actual giant wads of money they are making off you right now.

  • avatar
    carlisimo

    “And just like the 2008 mortgage crisis, these sub-prime auto loans are being packaged and sold as AAA rated bonds.”

    Wait… really? How badly do we have to screw things up to learn a lesson? Seriously!

    • 0 avatar
      highdesertcat

      That’s exactly the point, isn’t it?

      There currently are a number of repo’d cars and trucks parked at banks and credit unions in my area because young people defaulted on their car loan (for whatever reason). Bottom line: they could not pay!

      Not one car was repo’d because some old dude croaked before paying off his loan, or otherwise failed to make payment on it.

      So lenders are willing to lend to risky/unstable/unreliable young people who default on their loans but punish old people who have stable, fixed incomes with outrageous APRs and tacked-on charges when they want to borrow money to buy a new car or truck.

      What has happened to America? I remember a time when creditworthiness wasn’t a dirty word and lending didn’t involve special circumstances for different classes of borrowers. Age discrimination? Subprime lending to seniors? You decide.

      I will say that USAA is a fair and equal opportunity lender, but not everyone can qualify to join USAA.

  • avatar
    WRohrl

    There are plenty of people out there that had good credit and for whatever reason either were foreclosed on or chose to be foreclosed on. Most of those people saw their credit scores ruined – which may have been a calculated (and possible wise) decision for at least some of them. Most of those people did not end up homeless, they ended up becoming renters. The housing mess hit its peak around 2008, 5 years ago. Many of those people are in the market for either a new car or a different car due to whatever their circumstances may be. Even if they are paying some exorbitant interest rate, if they can fit it into their current budget, and the average term is 6 years, then they will be done with their obligation 6 years from now, which no matter how you slice it is a lot more palatable that sucking up a loss for the next 30 years from a standard mortgage that went completely underwater. If they bought a new car, it will probably even last those six years without major repairs. In addition, it is easier to continue paying a $400 or whatever/month car payment than a $2000 or whatever mortgage payment. I just don’t see what the big issue is.

  • avatar
    el scotto

    Not exactly the same. Not everyone can/should buy a house. Just about everyone needs a car. Sometimes medical bills, job loss, a bad divorce (as if there good ones) leave people in a financial pinch. Buddy of mine declared bankruptcy to medical debt. He got hosed on his next car loan. Why did he pay 18.7% on his car loan? He needed to get to work.

  • avatar
    MadHungarian

    Another factor in the profitability and “security” of subprime car loans is that the bankruptcy laws were amended in 2005 to prevent most borrowers from writing the loan down to the depreciated market value of the car. Many defaulting borrowers will file Chapter 13 and if they want to keep the car, they have to pay the balance off in full. They can reduce the interest rate (BHPH lenders are definitely not fans of that), but the lender gets paid every month by the bankruptcy trustee, at least unless the borrower loses his/her job and defaults on the repayment plan.

  • avatar
    nrd515

    I’ve got to admit I really don’t understand the whole “credit game”. My sister has had the same job forever (35 years, about 4 years from retirement, if she wants to, if she wants to, she can go till 70, owes only a small mortgage payment, and had to go the high interest thing to get a new car. She drove the last one, a Mazda 6, (I think) into the ground, and had to get something quick. I think she’s paying 12%. Her credit score is like 650, and she put 5K down, plus $1500 trade in, on the new one, but still had to pay ridiculous interest rates on the new Accord she bought, (and admits, she hates, she liked the Mazda better).

    A young guy I’m friends with has no credit, but a real SOB of a dad who he has a iffy relationship due to his dad basically destroying the family during his divorce, both financially and relationship wise. His dad is LOADED, to put it mildly, a partner in a huge law firm, and of course, dad wouldn’t give him anything, not one dime, towards a car when the motor in his Eclipse tossed the rods out of it. So, off to J.D. Buyryder, and hello 21% interest on a decent, but not great, and overpriced to boot, Taurus. By the time it’s paid off, the car will be junk, and he will probably have to pay big for another one, unless dad helps him out. Dad’s girlfriends get rocks the size of golf balls, his two kids get zip. I’m glad I didn’t have parents like that.

    • 0 avatar
      DenverMike

      “…his two kids get zip. I’m glad I didn’t have parents like that.”

      I had parents exactly like that and got absolute zip. Except they were poor. I started a business and made them partners and we do alright, but far rich or poor.

      I’m not sure anyone deserves free things or a free ride, even if their parents are multi-millionaires. If they earn it, it’s a different story. I’m sure they’re not.

  • avatar
    vww12

    BS article.

    Scapegoating Wall Street?

    Wall Street is merely trading the financial assets created when people take more credit than they should.

    It is not Wall Street’s fault that some bozo out there overleverages herself with a car.

    Don’t blame the intermediary.

    The fault is entirely that of irresponsible consumers who get into more debt than they should.

  • avatar
    henkdevries

    Thanks Derek for the article (and the other in the series) and all commentors too!
    Great to get an insight in car loans and on the inner workings of credit ratings for individuals.

  • avatar
    shaker

    It’s good to be reminded that the “economy” is based on debt rather than productivity.

    “House of Cards” indeed.

  • avatar
    jim brewer

    Call me old-fashioned. I’m in favor of usury laws. Very little societal good comes out of these loans and plenty bad. Allow a rate say 600 basis points above a non-subprime rate. Plenty of room to maneuver for the lenders and credit challenged buyers and you still lop off most of the problems.

  • avatar
    hreardon

    I have a client who owns a chain of 51 auto-title loan shops. Basically they give high interest loans to people who sign over their cars’ titles.

    The default rate over the last 3 years? Averages less than 5%

    To quote him: people need their cars to survive. They will pay the auto loan before they pay the mortage or rent because they know it’s harder to get evicted than to lose the car.

  • avatar
    doctor olds

    The Financial Crisis of 2008 was the result of $billions in home mortgage defaults, which through Credit Default Swaps,collapsed the money supply, the ability of lenders to lend, and killed the car business as a side effect of the credit freeze.

    GM created GM Financial for the specific purpose of sub-prime lending.

    Auto loans never were, and never will be the cause of “catastrophe” like the ’08 crisis. Automobiles can easily be re-possessed and resold.

    Much ado about nothing? Or is it a profound misunderstanding of what happened to the car business in ’08?

    • 0 avatar
      28-Cars-Later

      I would maintain GM had been teetering since the so called crisis of 1992 and the freeze up of the credit market was enough to push them over the edge. You as an insider Doc Olds could certainly shed light on this hypothesis having seen GM long before and long after this period.

      http://www.businessweek GM com/stories/1992-11-08/crisis-at-gm

      • 0 avatar
        doctor olds

        Yes, its fair to say that GM was under financial stress for a long time. We suffered from a freeze in product development spending from that time. We made some fair profits some years, a lot from GMAC at times. I noticed that GM’s annual $sales fell about $50B when GMAC was put under Cerberus majority ownership to boost credit rating and the sales no longer were part of GM.

        GM Financial, as Sunridge Place explained very well, is part of GM’s rebuilding the financial machine it needs to thrive in global competition.

        Subprime automobile loans are no big deal, certainly not a financial risk to GM.

        Now, I just heard on WJR that the President wants to push banks to make more subprime mortage loans again and that should scare you!

        • 0 avatar
          28-Cars-Later

          Everything that man does scares me.

          • 0 avatar
            highdesertcat

            And what is past is prologue.

            doctor olds is right in that car loans, even the subprime ones, will never cause a catastrophe like that of the housing market subprime loans.

            But what bugs me the most about any subprime loans that are underwritten with taxpayer money is that it allows people with no money to gamble with other people’s money at zero risk.

            Such a deal!

  • avatar
    drago

    TD Economics wrote a report on credit conditions in the US auto sector a couple of months ago:
    http://www.td.com/document/PDF/economics/special/AutoFinanceA%20BrightSpotForUSLenders.pdf


Back to TopLeave a Reply

You must be logged in to post a comment.

Subscribe without commenting

Recent Comments

New Car Research

Get a Free Dealer Quote

Staff

  • Authors

  • Brendan McAleer, Canada
  • Marcelo De Vasconcellos, Brazil
  • Matthias Gasnier, Australia
  • W. Christian 'Mental' Ward, Abu Dhabi
  • Mark Stevenson, Canada
  • Faisal Ali Khan, India