Are Auto Loans on the Verge?: NMA E-Newsletter #442

For the past couple of months, there have been rumblings that auto loans are indeed on the same downward spiral as home loans were in 2008.  Fitch recently announced that loans issued in 2015 may end up being the worst performing ever in the history of auto-loan securitizations. Fitch rates the loans as cumulative net losses projected to reach 15 percent, exceeding the peak loss during the 2008 financial crisis.

This is a slow-moving train wreck however because experts are unsure about loans issued in 2016. The auto loan instability has to do with the fact that institutional investors grabbed subprime auto loan securities because of higher yields (similar to the subprime house loan crisis of 2008). These subprime auto loans have been repackaged several times over and stamped with a high credit rating.

Negative equity has hit an all-time high. During the first three months of 2017, the average negative equity per traded vehicles reached $5,195 which is the highest ever according to Edmunds.  Also the highest ever—the 32.8 percent of trade-ins with negative equity.  When the negative equity is then rolled into the new loan for the new vehicle—the consumer starts in a steep hole. In the event of a loan default, net losses soar.

Why all this negative equity? Business Insider says there are three reasons:

1)    Even though vehicle prices have gone up, consumers buy more expensive models because interest rates are low and longer loan terms keep the payments at an affordable monthly cost.

2)    Loan terms are longer. In the first three months of 2017, loan terms reached a record 69 months. Terms between 73 and 84 months (seven years) accounted for 32.1 percent of all vehicle loans in the fourth quarter of 2016, up from 29 percent in 2015 during the same period. Used-vehicle loans accounted for 18 percent, a two-percent increase from 2015.

3)    Used vehicle values are falling. In May, the Used Vehicle Price Index by J.D. Power Valuation Services declined for the tenth month in a row.

Also, just like with the mortgage crisis, many consumers who are seeking funds to buy a car do not really have the credit rating or the money to buy a car but are lured in with less than stellar lending practices. This usually means much higher interest rates for people who are already on the edge financially.

How can all this affect a motorist?

The New York Times recently profiled a subprime auto loan borrower named Yvette Harris who is still paying off her 1997 Mitsubishi even after it was repossessed.  Her auto lender took her to court and garnished her wages in order to pay off the difference of the sale value of the car and the outstanding loan. This is now a common practice of subprime lenders. Unable to recover the balance of loans by repossessing and reselling the cars, some are aggressively suing borrowers to collect what remains.

Why not take the chance on a risky borrower?

If he or she defaults, subprime lenders can repossess the vehicle and persuade a judge in 46 states to garnish the borrower’s wages to cover the balance of the car loan.

The impending subprime auto loan crisis might indeed be worse than the recent subprime loan mortgage crises for individuals. With a mortgage, a homeowner could turn the keys in and walk away. Not so with auto loan debt. Repossession is just the beginning of the quagmire for many car owners caught in the subprime auto loan trap. New York Legal Assistance Group consumer lawyer Shanna Tallarico said, “Low-income earners are shackled to this debt.”

In February, a Bloomberg article stated “To be clear, this doesn’t point to an imminent, 2008-style meltdown. After all, the U.S. auto-loan market is about $1.1 trillion, which pales in comparison with the $8.9 trillion U.S. mortgage market and $8.6 trillion of dollar-denominated corporate credit. And only about one-quarter of the outstanding car loans have been extended to subprime borrowers, who are the ones having the problems.”

Yvette Harris, the single mother living in the Bronx, mentioned earlier says this has been a nightmare. Even after $4,133 of her wages were garnished and she paid an additional $2,743 on her own, the lender still sought an additional $6,500. All for a vehicle that probably has a blue-book value less than $2,000.

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