Will You Be Part of the Subprime Car Loan Crisis…?

by Will Lipovsky · 11 comments

under heavy debt
The mortgage crisis of 2008 was a period of time that will forever be remembered. It affected thousands upon thousands of people and threw not only the United States, but the whole world into a sever recession. Behind the great depression, this is arguably the worst financial disaster to happen in modern times. More recently, the subprime auto lending industry has been noted as having the same ingredients as the subprime mortgage and that a so-called bubble is due to pop.

Lenders are lending to people with below average credit and the effects of this have elevated the number of delinquent loans. Although the subprime lending industry has hit an alarming number, it is only about 1/10th of the mortgage crises in dollar size. It won’t be slowing the world economy but it’s large enough to make waves and turn peoples heads. There are three major reasons why the auto industry is headed for trouble. The promotion of lending to unqualified applicants, the push to sell cars, and the lack of knowledge by the consumer to know they are unable to afford the purchase.

Though the mortgage market is a magnitude bigger, the prime and subprime lending in the auto industry topped $1 trillion last year. The issue now is the delinquency rate, which Money.cnn.com reports topped 5% in February, greater than numbers pre great recession.

Automobile companies are always attempting to push sales, and many, if not all of them, were severely effect by the 2008 financial crisis and continue to recover. With the addition of subprime auto lending, it allows cars to move quicker which allows companies to produce more. More recently, with the growth of the economy and low rates, people have taken advantage of this rare opportunity of low interest rates and until something changes with the flow of lending, this is going to continue.

The responsibility ultimately lies with the consumer and their ability to judge if they can afford an automobile in the first place. Everyone focuses on the greedy banks and dealerships but the consumer is a major contributor to this potential crisis. Once a new or used car rolls off the lot, value is lost immediately. That’s why auto loans are one of the quickest ways to become upside down on a loan.

While auto lending is a large business, consumers need to be aware of what’s happening.

The average subprime auto loan interest rate can get close to 10%, which is insanely high. So be sure to do a healthy amount of research before you go out and attempt to obtain a loan. As if you were investing in a stock, think of it as investing in a car. Yes, you will lose value but be sure to choose the correct loan terms and vehicle, as well as fully understanding the agreement. Also, the best possible solution is to just pay with cash. Chances are that subprime lending in the auto industry will continue until the economy decides to slow down or the auto industry beings to slow down.

It’s no doubt the auto lending industry is in a bit of a financial crunch. Although it would not be as catastrophic as the mortgage crisis, it would be significant enough to affect the auto industry, which then ripples through many other areas of the economy. Some simple precautions that the consumer can do is to not take out a loan they can’t afford. Look at interest rates and make sure you can make the payments, or, just save cash and bypass the lending process all together. Banks and dealerships need to take on greater responsibility to prevent situations such as this too, but good luck with getting them to behave in any way that hurt sales. As is said, history tends to repeat itself. Make sure your car won’t wreck your finances.

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  • Ryan G says:

    Sorry, but car buying has been on my mind recently. My family is repatriating to the US from a short stay in Singapore. We sold both our cars before we moved, and so we have the opportunity to buy new vehicles. My wife moved home early and bought a lightly used Ford Focus ST at a good price, with low mileage and some remaining factory warranty. I won’t move back for another 5 months, so I can take my time selecting and hunting for a vehicle to meet my needs.

    The author pointed out that the sub-prime bubble is only 1/10th the size of the housing bubble, and that will help prevent major economic impacts. So the total amount of money is less, which is good. It is also spread out across a large number of assets that are relatively easy to sell.

    Part of the problem with the housing bubble was that it over-inflated the value of the physical assets by pumping a lot of cheap money into a system that had a relatively inelastic supply. Demand was driven up thanks to cheap/easy money, and the value of the underlying assets was pumped up accordingly. I don’t think we are seeing the same thing in car sales. There are certain, high demand models that command over asking price, but in general, new cars sell for less than MSRP, and used cars sell for less than new cars.

    My point here is that the value of the underlying assets is not over-inflated nearly to the extent that housing values were. Someone who bought a 5 year old RAV4 for $12K and is paying 10% at the buy-here pay-here lot may have overpaid for the car, and is certainly overpaying on the interest, but loan itself isn’t overvalued significantly relative to the value of the vehicle.

    So, when the bubble finally does burst, the size of the problem isn’t as bad as the housing market, and the value inflation isn’t as bad. Plus, it is a lot easier to repossess and re-sell a vehicle than a house.

    For people who will pay cash for cars, the sub-prime auto bubble may create an opportunity in two ways. 1) There will be an ample supply of used vehicles, which will tend to push down prices. This will, in the short term, lead to fewer people selling/trading their current vehicles because of crappy trade values, so the market will rebalance when the oversupply unwinds. 2) There might be some good deals on new vehicles. If fewer people can get qualified, there will be fewer buyers for new cars, which is the lifeblood of the auto manufacturing industry. I imagine that this will create a lot of incentives to move vehicles.

    It might be a good time to sit and wait if you are thinking of purchasing a vehicle. The real question is when will this bubble finally start to pop?

    • David Ning says:

      I’m in the same camp as you in thinking that this bubble won’t be nearly as bad as the housing bubble. And with the reasons you listed, it might be conceivable that the bubble simply deflates instead of pops in the future.

      Of course, this will still mean low sales and thus more incentives so it pays to wait.

      In fact, I would argue that it always pays to wait whether there will be incentives or not because like you already said before, depreciation costs is so big it will cover all kinds of incentives.

  • Very interesting and, yes, I think you’re right that this will be a crisis in the future. Unfortunately, since cars are an essential need for many Americans, some people think they need a brand new car and that it will somehow save them money since they won’t need to worry about repairs (in theory). I read recently that the average car payment is now over $500, which is insane!

    • Ryan G says:

      The biggest cost you will pay over the life of the vehicle is depreciation. The problem is that people don’t see that cost directly like they do maintenance costs. A car will, on average, lose 20% of its value in the first year, and then 15% per year after that. Some vehicles, especially german luxury cars, have even worse depreciation rates.

      People justify new car purchases for all kinds of reasons… Maintenance, fuel economy, lowering payments, etc. The reality is that it is a better idea to stick with the car you have instead of selling it and buying a new car. There are exceptions to this rule of course… if a vehicle is no longer meeting your needs, for example, it would make sense to buy one that does.

      The problem is that the auto industry thrives on sales. Share holders demand growth. How do you grow auto sales? More importantly, how do you grow auto sales at a rate higher than population growth? You need to take market share from your competition. This has, in part, led to shady lending practices.

      • David Ning says:

        Haha lease and you won’t have to worry about depreciation (NOT!)

        You also have to factor in the taxes you need to pay whenever you buy a car to come up with how much you are really losing. It’s 8% in my county so if 20% is the number, you are pretty much losing 28% of the purchase after year 1 if you have to sell the car.

    • David Ning says:

      Wow $500 a month is the average? That’s insane. Add gas, insurance, maintenance etc and that’s something like $10,000 a year. No wonder why no one can get ahead in this country when families with two cars are spending on average $20,000 each year just on car expenses.

  • freebird says:

    No I don’t fear the repo man, I’ve always bought used cars for cash.

    Still I’m unhappy with the way the auto industry has evolved over the years, always choosing feature bloat over cost reductions on basic transportation. Perhaps channel stuffing is their only recourse in an era of stagnant wages. Hopefully the new wave of entrants into self-driving vehicles take heed and create a value priced tier for those of us who don’t buy into status symbols (or vendor financing).

    • Ryan G says:

      Auto companies aim to make cars that will do two things… 1) sell 2) net a good profit margin. I believe there is demand for less expensive, basic vehicles. I would love a “compact”, no-frills pickup truck as a 3rd vehicle. I think there would be a market for a sub $10K subcompact, small engine vehicle. Unfortunately, auto companies won’t make these cars. They will blame safety standards for the need for larger vehicles, and consumer demand for expensive, feature rich vehicles. However, the real reason they won’t make them is simple. If they can make a vehicle for $15K and sell it for $25K, they make $10K of profit (good). If they add some features costing them $5K and can sell the resulting vehicle for $35K, then they can make $15K of profit (great!). However, to make that same $10K of profit on a $15K car, they need to produce it for $5K, which is really difficult. Or, to sell that $15K car, they need to accept a smaller profit margin. Accepting that smaller margin might be OK if they could penetrate an untapped segment of the market and gain market share. But the manufacturers figure they can tap the market segment that would buy a $15K car by offering longer loan terms on a $25K car. After all, it isn’t the cost of the vehicle that is important, just the monthly payment, right? (Wrong!)

      • David Ning says:

        I think you are onto something. My friend owns a small Ford pickup and he said that instead of depreciating, his truck’s value went up a good few thousand dollars because you just can’t find those small pickups anymore.

        And I just did a quick search and it seems like Ford is planning to return to the small pickup market. Of course, you just don’t know what they mean by small nowadays because even mid size sedans of the own days are the size of subcompacts of today!

        • RyanG says:

          The new Ford Ranger is a much bigger truck than the old Ranger. It is the size of an older model F-150. It will be cheaper than current F-150’s, but that isn’t hard to do. It isn’t going to be cheap like older Ranger’s were cheap, unfortunately. People who want a small, simple work truck will be out of luck. The F-150 is Ford’s work truck platform… larger businesses are willing to pay the price. Unfortunately, the small business owners or one-man shops that could really benefit from a small, simple, cheap work truck are out of luck.

    • David Ning says:

      I wonder how long it’ll take for companies to start mass producing cars directly aimed to be “transport only” vehicles. With self-driving cars and services like Uber maturing rapidly, there’s got to be a market for mass market self driving taxis where the main concern is safety and cost to own.

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