You’ve seen it on billboards. You’ve seen it on TV and on the back of the Sunday paper.
“No credit? No problem!”
Car dealers – particularly used car dealers – want to make it clear to consumers that bad credit isn’t an obstacle. If you need a car and you have poor credit, they’re got a deal for you.
The problem, however, is that while these poor credit/no credit loans may seem like a good deal (especially if you’re desperate), they can put you in a very dangerous financial position.
The Subprime Boom
As most people remember, the financial collapse in 2008 was tied largely to the prevalence of subprime mortgages sold throughout the early to mid 2000s. In essence, consumers were receiving home loans with terms they couldn’t really afford.
While subprime mortgages are thankfully not as much of an issue now, we’re starting to see similar patterns emerge in the auto loan industry. In October, Thomas Curry, who serves as Comptroller of the Currency, stated that some of the behavior in auto loans “reminds me of what happened in mortgage-backed securities in the run-up to the crisis.”
The numbers definitely support Curry’s concern. As reported by The Wall Street Journal, lenders doled out over $55 billion in subprime auto loans through the midway point of 2015. That’s 13 percent more than were closed during the first half of 2014, and 181 percent more than were closed during the first half of 2009.
Overall, subprime loans accounted for 20 percent of all auto loans originated during the first half of 2015, which is the highest percent since 2008. This all seems to indicate that lenders are increasingly willing to take risks on borrowers who may not have the financial means necessary to keep up with their new debt obligations.
The Trade Off
As in any credit or lending situation, if you don’t have a strong credit history lenders will look to mitigate risk by tacking on additional fees or a higher interest rate. In these subprime auto loans, the added fees and higher interest combine to raise the overall cost of the loan. This means that even a seemingly affordable used car becomes significantly less affordable.
In order to make these loans more manageable on a month-to-month basis, lenders are increasing the length of the loan. In the 2nd quarter of 2015, 29 percent of all new auto loans closed with repayment periods between 73 and 84 months, which is 20 percent higher than the year before.
The immediate danger of these subprime auto loans is twofold: first, borrowers are taking out loans that stretch or exceed their financial capabilities; and second, because these loans have such long repayment periods and are stuffed with so many fees, borrowers are often saddled with a car that’s worth significantly less than the amount owed on the loan.
If that scenario looks familiar – borrowers struggling with underwater loans – that’s because it strongly echoes the plight of homeowners during the collapse in 2008. That’s not to suggest that auto loans are definitely going to drag us down into another national economic downturn. More concerning, at least immediately, is how these loans impact consumers on a personal level.
There’s no denying that for many owning a car is an essential necessity. These subprime auto loans exist because people with bad credit or no credit very often don’t have the ability to simply say, “I guess I just won’t have a car.” However, that doesn’t change the fact that these loans put borrowers in a very bad situation.
Building Back Up
Just because you had to use one of these subprime loans in order to purchase a car doesn’t mean you have to live with it. If you make all of your car payments and stay current on all of your other credit obligations, eventually your credit score should improve. Once your score has improved, that opens the door to a potential refinance, where you should be able to get significantly better loan terms.
Meanwhile, if you’re struggling to stay on top of your loan payments consider speaking with a budgeting specialist. A trained financial counselor will be able to help you analyze your income and expenses and provide you with advice and suggestions for making the most of your money.
Auto loans aren’t quite approaching crisis levels just yet, but these subprime trends are worth keeping an eye on. If nothing else, it’s a reminder of how financial setbacks have a way of compounding, and why it’s so important to build and maintain a healthy credit history.