For the majority of Americans, owning a car is a necessity. Even if you live in a large city, you may not have access to public transportation that can get you where you need to go. Yes, there are more ride sharing and car sharing services out there, but at the moment, they aren’t a viable option for most people’s everyday transportation needs.
People simply need cars, and cars are expensive. This paired with the poor credit scores and low wages of many Americans means that people opt for a subprime car loan or a deep subprime car loan. According to Bloomberg, delinquencies on these types of loans is on the rise, and that’s not good for anybody.
What are Subprime and Deep Subprime Loans?
A subprime loan is a loan with a high rate offered to people who do not qualify for loans with lower rates. Deep subprime loans are loans with even higher rates than typical subprime loads. According to Investopedia, subprime borrowers often have low credit ratings or other factors that prevent them from traditional lenders. These folks are thought to be at a higher risk of defaulting on the debt repayment, so in order to loan them money, lenders charge higher rates.
These higher rates can lead to several thousand dollars more in repayment over the life of the loan. Different lenders offer different rates but the rates will always be considerably higher than the prime rate set by the Federal Reserve.
Subprime and Deep Subprime Auto Loans are Booming
From 2015 to 2016, subprime loans increased by 8.62 percent and deep subprime loans increased by 14.57 percent, according to Business Insider. That’s in just one year. This trend has been occurring for the last several years. In fact, the automotive industry is behind a lot of the debt that many Americans have. In the U.S., just under $1.2 trillion in outstanding auto debt was accumulated in 2016, according to Quartz Media. A quarter of the loans that make up the total outstanding auto debt can be considered either subprime or deep subprime.
This type of automotive loan is booming because lenders are more interested in taking risks these days. After the regulations tightened up on the housing market due the economic downturn in 2008, lenders turned to the auto industry.
The auto industry doesn’t have some of the restrictions and watchdogs that other industries do on money lending, and this has led to lenders allowing and in many cases encouraging people who are buying cars to borrow more money than they should.
Many People Can’t Make Their Payments
People who have to go with subprime or deep subprime loans are already considered at a higher risk of delinquency on their loans. That mixed with the fact that they’re often given loans they can’t afford means many of them won’t be able to make their monthly payments.
The easy solution is for people to simply buy a car they can afford. However, when a person has a car salesman and auto loan provider pushing to get them into a nicer, more expensive car it’s not as easy for car buyers to buy well within their means.
The car buyer makes the final decision, but the car buying apparatus that is the dealerships and lenders don’t exactly set these buyers up for success. In many cases, they’re encouraging them to get into a subprime or deep subprime loan situation. This can lead to people falling deep into debt and suffering from financial problems for many years.
This Can Deeply Hurt Investors, Too
The situation with subprime and deep subprime loans is not all that different from the housing crisis of 2008. While auto loans aren’t as important a part of the economy, they still play a big role. Business Insider pointed out that if the subprime auto loan issue hit investors the same way the housing crisis did in 2008 at the same time as an economic downturn, it could have disastrous results for the overall economy.
The impact could be similar to that of the economic downturn of 2008. Financial institutions repackage the loan as an asset-backed security and sell that to investors. If the borrower can’t make the payments on his or her loan, the lenders, investors, and, of course, the borrower all lose.