With nearly one in five subprime auto-loan borrowers two months or more behind on loan payments, echoes from the subprime mortgage crisis that kicked off The Panic of ’08 reverberate again.
Delinquencies, according to Standard & Poor’s, are at highs not seen since 2010. That’s when the housing mortgage crisis peaked.
Just as subprime home-loan borrowers secured loans with deplorable credit scores below 600, high-risk subprime car buyers have flocked to car dealers for years. They drive off the lot with new cars.
Need a car?
No job?
No money in the bank?
No problem. Just see your local car dealer. Get a deal you can’t refuse.
Because so many buyers were in bad financial shape, those shiny new vehicles came with low monthly payments. Some stretched out for seven or eight years.
This sector of the auto industry – subprime loans targeting poorer consumers – helped fuel the auto-sales boom during stagnant economic growth. They were a big reason for auto sales’ growth.
And they may be a reason why this sector is about to take a hit.
But how much of a hit? How widespread?
Historically low interest rates set the stage to package loans – and crafty new-car marketing campaigns – to reach lower-income, higher-risk consumers. Investors backing these loans believed the risk of default was lower than with home mortgages because consumers can’t live without vehicles. So, making that payment would be a top priority.
But a prolonged sluggish economy and essentially frozen wage growth among these groups now challenge this logic. Consumer debt is rising. It hit $12.35 trillion in 2016’s third quarter. That’s a $63 billion increase.
Today, millions of Americans drive cars with “underwater” loans – they owe more than the vehicle’s worth.
According to credit-tracking agency Experian, the average car loan is 68 months, or more than 5.5 years. And many subprime loans offer payback periods of up to eight years, or 96 months.
Those longer payback periods guarantee the money owed outweighs the car’s value as the loan matures. Many loans taken out in 2013 or 2014 are guaranteed by an asset worth less than what’s due.
Sound familiar? That same circumstance fueled the housing-market collapse: Mortgage holders couldn’t pay. Lenders found themselves with delinquent loans. Balances were more than the home’s value.
But that’s where the scary similarities end.
The subprime auto-loan market is not big or widespread enough to derail the economy. It won’t cause widespread defaults among major lenders, tumbling banks as the mortgage crisis did.
Automakers, with only some exceptions, are not overly leveraged in the subprime market. Moreover, any significant burst of the auto-loan bubble would be triggered by a sharp weakening of the economy. I do not forecast that.
But delinquencies are accelerating. Lenders, who aggressively targeted this market sector and hold disproportionate amounts of risky loans, will be hit hard.
TRENDPOST: The overall risk to the economy of subprime auto loans remains more isolated than overriding. But if defaults hit hard and swiftly at a time when other economic indicators – market declines, rising unemployment rates, global declines – trend negative, the subprime auto-loan bubble burst could become a trigger for more macro-economic downward trending.