Subprime loans: they aren’t just for mortgages anymore. The next big bubble of ill-advised loans to borrowers who can’t pay is coming due. This time, it’s used car dealers reaping the interest and repossessing the cars.
The New York Times reports that subprime auto loans have risen over 130% in the five years since the big financial crisis hit in 2008. Over a quarter of all new auto loans issued in 2013 went to lower-credit borrowers.
The wave of questionable lending is being driven by exactly the same thing that drove the mortgage bubble, according to the NYT: Wall Street firms making a buck on trading packages of bundled loans. These complex bonds then increase the demand (from insurance companies, mutual funds, and financial companies, not from consumers) for more loans, triggering a big cycle.
The subprime loans, meanwhile, come with sky-high interest rates — up to 23%, reports the NYT. They add, “The loans were typically at least twice the size of the value of the used cars purchased, including dozens of battered vehicles with mechanical defects hidden from borrowers.”
Taking out a $15,000 loan at 23% interest to buy a $7500 car can kick off a spiral that puts already-disadvantaged borrowers right into bankruptcy court, the NYT found. It’s a game that subprime borrowers can’t win: they already have credit trouble and a lower likelihood of being able to repay the loans they are issued, and then the loans they get have terms that make them extremely challenging to pay back, so it ends in repossession.
So how are such high-risk borrowers ending up with their loans in the first place? The same way so many subprime borrowers ended up with huge, underwater mortgages, reports the Times: the people who fill out the paperwork are making stuff up.
The NYT, in their investigation, saw dozens of loans that “included incorrect information about borrowers’ income and employment, leading people who had lost their jobs, were in bankruptcy or were living on Social Security to qualify for loans that they could never afford.” Also at play, surprising exactly nobody, is that used-car sales staff were found to be extremely aggressive when pushing their product onto customers. Their tactics guide buyers into loans as large as possible, in less-than-ethical — and sometimes in downright illegal — ways.
In their role as matchmaker between borrowers and lenders, used-car dealers wield tremendous power. They make the pitch to customers, including many troubled borrowers who often believe that their options are limited. And the dealers outline the terms and rates of the loans.
In interviews, more than 40 low-income borrowers described how they were worn down by used car dealers who kept them in suspense for hours before disclosing whether they even qualified for a loan. The seemingly interminable wait, the borrowers said, left them with the impression that the loan — no matter how onerous the terms — was their only chance.
There’s a lot less money involved in car loans than in mortgages, so in the department of mediocre silver linings we can all take solace in the fact that when this bubble pops “its implosion would not have the same far-reaching consequences” as the meltdown of the housing market did just a few years ago, says the Times.
While mortgages are now aggressively regulated by the CFPB, the agency has no such authority over car dealers. So for now, the biggest banks are chasing subprime auto lending the same way they chased home loans six years ago. Wells Fargo, the second-largest subprime auto lender in the country, financed $7.8 billion in car loans last quarter.
In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates [New York Times]