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A Wakeup Call is Coming for Subprime Auto Lending

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April 22, 2017 – Comments (0)

For almost ten years, people have enjoyed the ability to borrow money at staggeringly low interest rates. It would appear that that time is almost over. Interest rates have slowly begun to crawl higher. The small increase in rates has already started to take a toll on the $1.1 trillion auto loan market that is unfortunately littered with bad subprime loans.
Lenders handed out offers that buyers simply could not refuse including zero down payments and extended loan periods that convinced consumers to engage in irresponsible borrowing. For many people that didn’t have the credit score or income to purchase a house, they could snag the next best thing. They would be able to drive a brand new car and a lot of people took advantage of that.

In 2017 there has been new data released about financing in the auto sector that has raised red flags about new car financing. The number of late payments from subprime borrowers is in a sharp rise while at the same time, new car sales have started to drop.

The recent decline in auto values was discussed by Fitch Ratings, Inc. in their latest report. According to Fitch, they took a look at NADA’s Used Vehicle Price Index and found a 6% drop in used car prices in 2016 and 8% through February 2017.

Fitch also found that the 60+ day delinquency rate on subprime auto loans is the highest it has been in seven years. They attribute this high figure to the fact that many new independent, less-tenured companies have entered the automobile financing business with less underwriting discipline than banks and an appetite for high risk loans.

One of the largest companies holding the subprime auto debt is Wells Fargo. Their investors saw the possible downside to this style of lending and as a result the company has taken new steps to protect it from risky auto lending practices.

If this trend continues it will mean that car lots across the country will end up with excess inventory. Excess inventory will mean that the prices will eventually have to drop to entice buyers to start purchasing again. This will also flow over into the used vehicle market and analysts at Morgan Stanley say that if new car prices drop it will also cause used car prices to drop. Some analysts are predicting a 50% drop by the year 2021.

People who puchased new cars on credit could face a similar situation that homeowners had to endure in the 2008 mortgage collapse where they found their property value fell so much that they owed more on their homes that what the market said the homes were worth. This time it would be with the value of the automobile that they drive. This type of problem in the auto industry would cause many consumers to sell their financed vehicles privately to try and get away from that debt and recover as much as they can.

The risk of loss from auto loan defaults isn’t with only lenders and borrowers. In a move similar to mortgage backed securities that failed in 2008, thousands of these subprime auto loans have been bunched together and sold in a similar fashion. Billions of dollars of these bundled secure auto loans have been sold off to investment fund managers that are trying to maximize their returns in a low interest rate environment. The end result remains to be seen but right now with the delinquent rate rising, it isn't looking too good.

Bad auto debt on its own will not destabilize the economy but combine it with higher rent rates and bad student loan debt and you get a drop in the net worth of many working class Americans. Instead of saving for the future, being ready to purchase a home, saving for retirement and building a solid investment portfolio the next generation will be working for the rest of their lives to try and become free of crippling debt in an economic environment that they simply do not understand.
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