Saturday, October 10, 2015

The Coming Crisis in Sub-Prime Car Loans

Car loans?  I wasn't even aware that such a thing existed, but I find in reading around that everyone in the business knows about them.  This company, for example, advertises they specialize in so-called deep subprime loans.   These are car loans for people with no credit rating or who are currently going through bankruptcy.  Everyone has to start somewhere, so I'm sure some kids with no credit experience sometimes absolutely have to get a car loan, but they pay desperately for them.  According, a well known car market website, APRs for deep subprime used car loans averaged 19%. 
Here's how those numbers work out in real life for a 60-month loan amount of $16,333, using the average interest rate received by each group of borrowers with scores below 660.
  • Nonprime: 9.29 percent for 60 months = $341 per month
  • Subprime: 15.72 percent = $394 per month
  • Deep subprime: 19 percent = $423 per month
Remember, the finance companies, especially the big ones, are getting their funds to loan out at 19% for essentially 0% interest.  Didn't they used to call this usury? 

Aside from that, I see a couple of big problems here.  First, did you notice they referred to a 60 month loan?  Five years on a used car?  The lenders are stretching out the loan periods beyond that, up to 6 and 7 years. Given those 19 or 20 % interest rates, these car “buyers” won’t own any equity – zero – in the cars until after month 60.  I've said before I don't understand why house mortgages were never supposed to be underwater when car loans routinely are; this is an example.  For five or more years, the buyers have no economic interest in the vehicle they “own.”

The second problem here is that it's not just a small percentage of the buyers that need Subprime and Deep subprime loans at these high rates.  Consider General Motors.  Roughly 90% of GM car buyers finance their purchases, no surprise there, but as recently as 2014, 83% of their loan book was subprime, with a shocking amount categorized as “deep subprime.”  That means only 17% of buyers have good enough credit to get to "nonprime" and it's not possible to figure what percentages get "prime" or "superprime" rates.  Bonner & Partners continue their analysis with:
By the end of last year, total auto loans outstanding in the U.S. had reached almost $900 billion – up nearly 25% in only two years. Does that sound wise? Loans that originated last year have begun to default at a pace not seen since the 2008 financial crisis.

This problem is going to get a lot worse. It will probably result in bankruptcy at Ford Motor and massive losses to financial institutions that own these auto loans, like GM Financial and Santander Consumer USA.
I want to make it clear that I'm not saying bad things about people who have to get those loans.  Shit happens and bad shit happens to good people.  The thing that gets me is the idea that 83% of the people who finance GM cars are in the bottom two (of five) rankings for loans.  When that many people need to pay these outrageous rates to buy cars, I can't see how the system can survive.  

The crisis of 2008, which we aren't really over, was about too much debt on every level: homes, consumers, and businesses.  Has anything really changed?  


  1. You're missing something here. Namely, it is pretty to easy to repo a car. The car is then sold and the loss is not that great. In the meantime the high interest rates should make up for the defaults somewhat. There is a reason they are high in the first place. I think student loan debt is a much bigger problem.

  2. This week I saw an incredible billboard, that of a company offering great rates! to REFINANCE YOUR TITLE LOAN.

    Pawn the title, can't quite pay off the loan - hey, come here - we'll loan more on it.


  3. While it's easier to repo a car than a house, I'm not convinced the secondary market for these will be that great - first, it's a used car, which may have an uncertain heritage (and it wouldn't surprise me to discover that "used" in this case means "already repo'd once"), then the formerly used car got repo'd. I've seen bank repos I'd consider, but this is a different situation; if the second owner couldn't make the payments, was he even performing minimal maintenance? Discovering that it was a repo'd "used" car would immediately lower my opening bid by 50%. Some suckers will bite, certainly, but enough smarter buyers stay away and the article SiG quoted from will be correct: GMAC, Ford Credit, et al are headed for rough times and multiple "restructurings."

  4. I think a possible root cause, or just contributor is that old "cash for clunkers" program. At the time, the counter argument to doing it was that it was taking a lot of good, older cars off the market and making it harder for low income people to get a used car. These are exactly the kind of folks who would need these subprime loans.

    Right now, I think the dominant used cars being financed by GM would be the two year lease turn-ins. Cars they take on trade that they'd sell are only the top few percent, the rest they sell wholesale to smaller lots.

    Cars have gotten more durable and reliable; 100k miles isn't that unusual anymore. My current car is an '09 Explorer that I got in '12 with 47k miles on it. I have no doubt that with the 6k miles or so I put on it a year, it will last until I'm falling apart.

  5. I think there are 2 different factors mixed together in this discussion:
    - There are lots of people out there who are desperate for a car; if there weren't, there wouldn't be as many of those "Buy Here, Pay Here" dealers. They almost universally self finance because the regulations are almost non-existent. They also usually have older cars - 8, 10, 12 even 15 years old. I once had a discussion with one of those dealers who required a down payment of close to his purchase price at auction; monthly payments after that were gravy. He had cars he had repo'd and resold 5 or 6 times. He also tried to work with his buyers to keep payments going so he didn't have to repo. One thing he did was provide a mechanic at cost because he found people were less likely to default if the car kept running. From what I can tell, he is unusual for a 'Buy Here, Pay Here' dealer.
    - The subprime loans being bundled into securities are from major finance groups, such as you mention - GMAC, etc. These are for cars sold through GM, Ford, Dodge, etc major company branded dealers and are much newer vehicles, 2 to 6 years old, more or less. These dealers and financiers, like mortgage companies who service government backed mortgages, are all about the numbers. In a time when the stock market isn't doing well, the financiers are drawn by the chunk they get of 15% and 19% loans; even after servicing fees they could end up with 10% to 12% return.
    I would be interested in seeing what percentage of these loans default and are repo'd, or if they just add more fees and months onto the loans. With such long terms, it is essentially a long term lease since the loan is likely only paid off with a new loan on a newer vehicle years later. I've heard that some of these loans require a minimum number of payments and essentially can't be paid off early. What a mess - I think I'll stick to buying cars with cash!

  6. I had a family as renters in a home I owned. They couldn't even qualify to have the electric turned on so it was placed in my name. They constantly paid me late and often less than full payments. They both "worked" kinda and both needed cars. They bought perhaps 10-15 cars in the 5 years they rented from me. Some were repossessed, some fell apart, some were wrecked. They paid about 20% for their loans and had to come up with about 20% down. Rarely were the cars worth more then a couple thousand but typically they bought them for $5000 more or less. I can assure you the auto sellers and loan sharks didn't lose anything on these deals. I on the other hand lost about $3000 when the couple finally moved on. I had a handful of checks and a good case but you can't get blood from a turnip.

  7. I would venture to guess that most of the people that take these subprime and deep subprime loans, do so because they are spending $100-$200 a month for their cell phone bill, another $100-$150 a month on cable or dish, have 2-3 huge screen TVs in the house and a boat or jet ski or two in the garage. All purchased on credit, of course.

  8. SiG, I think you're right on the "cash for clunkers" thing. I have no idea how many fair to good used cars that took off the market, but I'm confident it was enough to dramatically change the used car market for years. There's a local outfit that owns a full set of the Asian dealerships, and their TV ads run non-stop during the evenings; I'm astounded at how much they ask for 10 to 14 year old tired iron. I suspect they may have discovered the "sell, finance, repo, resell" system is a profit center.

  9. If you start off with a subprime loan and work yourself up, you can get a pretty decent rate in no time! You just have to make sure that you meet your car financing payments on time and don't default!