Onerous Loan Terms Are Crippling Already Broke Subprime Auto Buyers


onerous-loan-terms-are-crippling-already-broke-subprime-auto-buyers

As the bubble in subprime auto continues to grow bigger – even at the same time the auto industry is mired in recession – terms on new loans for new buyers continue to get more burdensome for already broke consumers. 

In fact, many people are piling on debt to their auto loans that far exceeds the car’s value, according to the Wall Street Journal. Like homeowners during the financial crisis, this leaves many people with negative equity or “underwater”.

33% of people who traded in cars to buy new ones in the first nine months of 2019 had negative equity. This compares to 28% five years ago and 19% 10 years ago. The borrowers owed about $5,000, on average, after trading in their cars before taking on new loans. Five years ago that figure stood at an average of about $4,000.

And the rise in car prices isn’t helping, either. Easy lending standards are helping perpetuate the cycle, with lenders now issuing loans that can last 7 years or longer, as we have documented here on Zero Hedge. 

Borrowers remain responsible for paying their remaining debt even after they get rid of the vehicle that’s tied to it. When buying a new car, they just roll this debt into a new loan. Dealerships, who now make more money on financing than on selling the car, encourage this type of refinancing. 

Consumer lawyers say that customers are often forced to trade in their vehicles, either due to changing needs or vehicle problems. 

David Goldsmith, a lawyer who defends consumers in auto cases said: “These aren’t Rolls-Royces. They’re Ford Escapes.”

Borrowers that have negative equity at the time of buying a new vehicle are often saddled with longer loan terms, higher interest rates and higher monthly payments. The higher rates and longer amortization schedule means that a smaller share of their payments go to paying off their principal. The result is obvious: many consumers wind up deeper and deeper in the hole everytime they trade in a new vehicle. 

Underwater loans are most prevalent with subprime borrowers, mainly due to consumers with lower credit scores lacking the means to pay off the remaining balances on their loans before taking out the next one. In the even of a default, lenders generally take possession of the vehicles and try to resell them. That money is then applied to the unpaid balance, but often isn’t enough to cover the total balance. 

Most of these loans are originated at dealerships now, which then assign the loans to a number of lenders, banks and credit unions. Many loans are also bundled into bonds and sold to Wall Street.

The added debt from these loans can make it difficult for borrowers to stay current. 5.2% of outstanding securitized subprime auto loan balances were at least 60 days past due on a rolling 12 month average period ending June 2019. This is up from 4.8% the year before and 4.9% two years prior. 

Nicole-Malia Tennent and Shyanne Fernandez, both in their early 20s, are a perfect example. They sought to trade in the car they shared for something less expensive last year. They instead ended up splurging on a new vehicle and rolling over their $12,500 unpaid loan balance from their last car into a loan for a new 2018 GMC Sierra. 

The new loan balance stood at $66,000 as a result of the old loan being rolled over. They split the payment of $900 per month now, which they have 84 months to pay off. Their old loan was about $500 per month.

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