Sub-Prime Auto Loans Could Be in Trouble

As auto sales in the United States have rebounded, some investors have been putting money into subprime loans. Many lenders have loosened credit standards and raised interest rates to account for riskier borrowers. Some Americans say they knew the interest was high but signed the papers anyway because they couldn’t get to work without a vehicle. The subprime auto loan market is starting to look more and more like the subprime mortgage market from 10 years ago. Dealerships and auto makers are preying on desperate consumers by putting the borrowers into higher rate loans often worth more than the price of the vehicle itself. This means that higher-risk borrowers end up paying far more for auto loans than those classed as low risk.

One of many examples of how this market has perpetuated up to this point has been parents helping to buy their children cars without the proper income needed to finance it in a sustainable way. In once case a father wanted to buy his son a car for his high school graduation. So the father purchased the vehicle in his own name and paid $1,750 as a downpayment and the car was driven off the lot. But the issue is that the remaining loan for the car was $11,400 and this debt carried an annual interest rate of 29%, over nearly a four year period. The loan was in the father’s name, but his son would be the actual person responsible for making the payments. In the end the loan defaulted because the son wasn’t able to keep up with the payments. These are the kinds of loans that consumers are getting themselves into. Of course the automakers can reposes the car and keep all the interest and principal payment. But it’s the borrowers who struggle to make ends meet and still walk away with nothing. This is why going into debt without a solid plan to pay it off is a risky financial decision.

In its relentless drive for growth, even the peer-to-peer ride sharing service, Uber, has gotten into the subprime auto market. Uber is always on the lookout for new drivers, and many of those drivers require cars. To help them get started, Uber has been offering short-term leases through a wholly owned Delaware-based subsidiary called Xchange Leasing, LLC. It partners with auto dealerships, advertises to drivers, manages risk, and even hires repo-men to chase down cars whose drivers aren’t making their payments.

By the looks of things right now asset-backed auto securities appear to be a disaster just waiting to happen. The subprime market for automobiles has been growing since 2010. Although it is not a large part of the economy, the fear is that the problems in the subprime market might leak into the entire automotive lending space where seventeen and a half million vehicles are sold every year in the United States. The subprime housing market was fairly contained in 2005 as well, until it wasn’t and spread into the entire mortgage market.

If the subprime auto market crashes and burns within the next twelve months then that could be a catalyst to push the U.S. economy into a recession. With energy prices still relatively low there is a lack of interest for investors to jump into new oil or gas ventures right now. Employment data shows a slowing down of the labor market as only 38,000 jobs were added last month, raising concerns about the Fed’s decision to raise interest rates or not. But the U.S. isn’t the only country having a rough time lately. The World Bank has yet again cut its 2016 growth forecast for the entire global economy to 2.4% down from 2.9% that was estimated earlier this year in January. And it appears that emerging market countries are where the slow down is the greatest. As the world economy slowly chugs along it will be harder for Americans to find relatively safe yet profitable places to invest their money.

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