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Subprime Auto Loans: What Borrowers should Know

If you lost your house during the subprime mortgage crisis, whether via repossession or simple abandonment, have no fear. There’s at least one other big-ticket item that you can finance into oblivion, namely a car. With credit expanding after years of skeptical lenders holding their dollars tightly, the money market has liberalized to the point where more and more people can borrow to buy a vehicle. A few of them will inevitably default, potentially making subprime auto loans the latest in a never-ending series of crises du jour.

The Grass is Always Browner

No matter what happens in the economy, you can’t win. A bull market on Wall Street means that stocks are out of reach for the common man, while a bear market means that everyone’s 401(k)s are going to implode. That’s not hyperbole, either. People complained for years about high gas prices. Now that they’ve finally fallen, some chronic pessimists lament how cheap fill-ups leave governments with less gas tax revenue or increase the chance that oil-producing countries will default on their loans. Every silver lining has a cloud.

The same goes for auto lending. As the economy slowly recovers from its recent doldrums, people have more money on hand. And thus more capacity to borrow, and thus more actual borrowing. The Federal Reserve Bank of New York reports that household debt increased by $212 billion in the third quarter of 2015, a monstrous amount of money which means nothing without a frame of reference. It’s an annualized 7% increase, which doesn’t sound nearly as monolithic as $212 billion does. Also, greater household debt is an inevitable result of a strengthening economy, at least in a nation whose inhabitants have been socially predisposed to overspend for decades now.

The result is that more people can now afford down payments on cars, and are thus on the figurative if not literal road to greater autonomy, which certainly doesn’t sound like a bad thing on the surface. The price of loans adjusts to reflect that, with correspondingly higher rates being charged to people more likely to miss payments. There are also loan origination fees, much like those for home financing. These serve as a way for lenders to either squeeze more money out of the poor, or earn at least a few guaranteed dollars before default, depending on your perspective.

The Profit-Seeking Motive

Perspectives vary greatly. Academics and other doom-saying observers fear that subprime car loans will lead to the automotive equivalent of a housing collapse, however that might play out. Yet lenders aren’t in the business to lose money. Auto financing corporations know far more about risk than any hopeful borrower or authoritative regulator does. Why? Because the lenders have skin in the game. Thomas Curry, the Comptroller of the Currency, can afford to be wrong when he predicts that the auto loan market might bottom out; Ally Financial Inc., the nation’s largest auto lender, can’t.

The comparison to the mortgage market breakdown of the late aughts breaks down in other ways, too, but primarily for one manifest reason: cars are a heck of a lot easier to repossess than houses are. They also retain their value in a much more predictable way, less dependent on shifting local demographics.

Or, you can regard this from the borrower’s viewpoint. Taking out a loan at 7% to finance a car in an environment where the Federal Reserve chairwoman is toying with negative interest rates might sound dumb to someone with established credit. But it isn’t, especially if the only alternative is taking an Uber to work every day or losing out on a job opportunity because it requires an impractically long bus commute.

The Bottom Line

“Predatory” is a beautifully vivid adjective that’s used to describe high-interest lending. The word conjures up images of a red-tailed hawk descending on an innocent ground squirrel before tearing it to ribbons and savoring it for lunch. The one crucial difference is that the squirrel isn’t signing its name onto any voluntary agreement. That’d be suicide. Unfortunately, there are a lot of consumers who aren’t quite so committed to their own preservation. Millions of borrowers are set on taking possession of something shiny that they want today – a house, a car, a college education – and only later on will worry about the uncomfortable details of paying for it.

For the prospective car owner (or more accurately, car financer) who wants wheels and doesn’t have the capacity to pay cash nor to take advantage of low interest, the answers are simple and varied. Save more money. Shop for something cheaper. Wait. A little forbearance and the problem will disappear.

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