A Car Loan Study Is The Scariest Thing You’ll See This Halloween
Auto loans have long been what we call in the industry “a shit show. “Long term, high payments and predatory lending tactics have dominated the industry for years. Now a Terrifying Consumer Reports Study shows that things are worse than previously thought – and with increased investment in auto loan-backed securities, another financial crisis could be brewing. Double, double, hard work and difficulty.
Before entering some Big shortinvestment style speech, let’s start with the Consumer Reports study. After examining data on auto loans issued in 2018 and 2019, the organization found that the auto loan market is a real Wild West – a poorly regulated wasteland, where every participant participates for themselves.
Consumer Reports spent a year analyzing more than 850,000 auto loans from 17 different lending institutions. Data showed an average monthly payment of almost $ 600 for new cars, a 25% increase over the past decade. Strangely, this is not the worst:
The investigation revealed:
- A credit score does not necessarily dictate the terms of the loan offered. Borrowers in all credit score categories, ranging from super-prime, with scores of 720 and above, to deep sub-prime, with scores below 580, got loans with APRs ranging from 0% to over. 25%.
- Some high credit scorers get high priced loans. While on average, borrowers with low credit scores are offered the worst terms, around 21,000 borrowers with prime and super prime credit scores, about 3% of total borrowers in this group, received loans with APRs of 10% or more, more than double the average high-score rate in our data.
- Many borrowers are put into loans that they might not be able to afford. Experts say consumers shouldn’t spend more than 10% of their income on a car loan. But nearly 25 percent of loans in the CR data examined exceeded that threshold. Among high-risk borrowers, this number is almost 50%, about 2.5 times more than high-risk borrowers and high-risk borrowers.
- Underwriting standards are often lax. Lenders rarely checked borrowers’ income and employment to confirm that they had sufficient income to repay their loan. Of the CR loans reviewed, these checks only took place 4% of the time.
- Unpaid bills are frequent. More than 5% of loans in the data – 1 in 20, or around 43,000 in total – would have been in arrears. As defaults have declined over the past year and a half, likely thanks to pandemic-related postponement programs, industry groups and regulators are bracing for a potentially sharp rise in the coming months.
Scary enough for you? Car buyers, regardless of their credit score, end up with high rates; either to enrich the financial institution that took out the loan, or to earn the dealer a few extra dollars in bribes. Often, underwriters do not even do basic due diligence to verify that the borrower can to afford the loan – just raise the rates until the buyer says “uncle”.
Five percent of auto loans in the United States are in arrears and nearly half are underwater. With both New and Used vehicles soaring costs, and loan deferral programs due to Covid stopping, that pattern shouldn’t change anytime soon. At least that won’t change for the better.
Much like some late-stage trick or treat, when houses run out of candy, things only get worse from here. You may remember a little niche historical event called “the 2008 financial crisis”. If not, please don’t leave a comment and make me feel old, but here is the basic story:
Investors invest huge sums of money in mortgage-backed securities. Essentially, investors would lend their money to banks to fund mortgages, in the hope that those mortgages would be paid off and investors would reap the interest as a reward. But those mortgages were fundamentally unhealthy and were never paid off: billions of dollars disappeared from the financial system, banks closed and the world still has not recovered.
Now the same is happening with auto loans. Auto loan-backed securities are all the rage, with investors pumping money into an already crowded market. Although auto loans are becoming increasingly precarious, the prices of bonds based on these loans continue to rise. Of MarketWatch:
New risky auto bonds with ‘trash’ BB ratings have sold this month for yields as low as 3.5%, up from 9% four years ago, according to the bond monitor Finsight platform.
Demand has been so strong for low-rated subprime auto bonds that some investors are now feeling squeezed out.
“As this year dawns, there has been more liquidity looking for auto ABS,” said Toby Giordano, portfolio manager at Braddock Financial in Denver, Colo., Buyer of BB-rated subprime auto bonds, said or asset-backed securities in recent years.
Falling yield on a bond where yields are stable means raising prices – the prices that investors are willing to pay to enter this house of cards market.
The incredible neglect of auto loans is frightening already, but the amount of investment invested in auto loan backed securities is downright terrifying. Rising defaults and defaults mean investors will never see their “stable” asset-backed Return. It doesn’t take a crystal ball to see where things are going from here – just a glance at what happened a decade ago.