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Reckless Driving: Implications of Recent Subprime Auto Finance Growth

January 13, 2015
Auto Loans

The auto finance market has grown significantly in the past few years. According to Experian Automotive, outstanding auto loan balances reached a record-breaking $870 billion in the third quarter of this 2014, an increase of 9.9% and 24.5% over the same periods in 2013 and 2012, respectively. As of the end of the third quarter of 2014, loans to consumers with below prime credit comprised 38.7% of open accounts, totaling over $336 billion. Also, according to the Federal Reserve, "The dollar value of originations to people with credit scores below 660 has roughly doubled since 2009, while originations for the other credit score groups increased by only about half." Likewise, subprime auto loan securitization issuances stood at $13.7 billion in 2013, more than 12 times the issuances in 2009.

This growth raises concerns that subprime auto lending practices risk causing problems in the larger auto market. In this article, we look at delinquency and default rates and explore whether auto loans are in fact performing better than mortgage loans did in the period before the mortgage meltdown or whether the current statistics may be misleading. We also look at the issue of lengthening loan terms and rising loan-to-value (LTV) ratios and what those changes mean for potential risk. Finally, we explore the recent discussion about a potential "bubble" in the auto lending market and highlight existing abuses that, if eliminated, would reduce risks in the market.

We find:

  • Repossession rates have climbed significantly in the last four quarters;
  • Lenders are loosening underwriting standards and extending loan terms while increasing auto loan amounts, increasing the risk of defaults, particularly for subprime auto loans;
  • Dealer interest rate markups and selling and financing add-on products exacerbate the risk of default and increase risk disproportionately for borrowers of color; and
  • Efforts to minimize auto loan repossession rates by comparing them to the mortgage market are misleading.