“No credit? Bad credit? Pulse? 100 percent approved! Sign here and drive your new car home today.” What they don’t say is that the people who have no credit or bad credit qualify as “subprime,” that is a FICO score at or below 640, and they stand a 10 percent chance of having the lender take that car back.
One of five car loans is made to a subprime borrower, that’s 11.5 percent for new cars and 32.2 percent for used cars. Experian, the credit reporting company, predicts that this year one in 10 of subprime buyers will have that car taken back by the lender. What that means is that there is a good chance these folks won’t be able to get to work. No car, no work; no work, no rent; no car, no employee. That’s the risk employers and landlords take when they accept an applicant who is in over his head with a car loan. Which buyer will lose the car? No telling, but the lower the credit score, the more likely he or she is to end up taking the bus to work, if there is a bus.
After their big increase, car sales have plateaued. That means car dealers have to get more “creative” if they are to continue to turn the profits they are accustomed to.
Subprime car buyers face two problems because of the need for dealers to get “creative.” The first problem is if, say, they buy a car for $20,000. Most car loans today are for six years, 72 months. Subprime borrowers, those with a pulse and a 580 FICO score, can pay up to 15 percent interest on a car loan for a car that might even still have all its wheels after six years, but likely won’t be particularly reliable long before that. That means they trade in their old car for another one before the old one is paid off. Trouble is, at that point, they still owe on the original loan. A $20,000 loan at 15 percent over six years means a payment of $422.90 a month. That’s before the additional payment for the old car is added on.
The car dealer then puts the two loans together into one “easy” payment. Granted, the dealer can probably sell the car for part of its loan balance, but the rest gets tacked on to the new loan. That can easily mean a car payment of over $600 a month for a car that has little chance of surviving the loan period and in an amount that may be about as much as the buyer’s rent.
The second problem comes if the buyer doesn’t make payments and the dealer comes and takes the car back. Our car buyer is not finished paying off the loan, or the lender wouldn’t repossess the car. Edmunds.com points out that a car loses 11 percent of its value the moment it leaves the lot, and it gets worse from there. They have found that a car depreciates 15 to 25 percent every year. At only 15 percent, after only one year, that $20,000 car has a depreciated value of $15,130. Presumably, that’s about what the bank could get for it. Trouble is, the original borrower still owes $17,575. That’s where the bank will want to make up the difference in what it can sell the car for and what is owed.
So no car, no job, no place to live, and continued car payment debt.
The car dealers are in the clear. They sell cars, write loan apps, which may or may not accurately reflect the buyer’s income and employment, and turn the loan over to the bank or whomever will finance the loan. The actual lender isn’t too careful either because just like the home loans of a few years ago, car loans are packaged and sold as securities, thrown together with other subprime car loans. Investors buy these because the interest rate is so good. Where else can someone get 15 percent on his money?
Up until now, it hasn’t been a problem. The number of loans in default is “tolerable.” But with 10 percent expected to default this year, it is beginning to be a problem. Even so, that’s not anything that employers or landlords need to worry about unless they have invested in subprime auto loans. What they might want to think about is whom they hire or rent to. If someone can’t make the car payments and the bank comes and takes the car back, the employer may lose an employee and a landlord may lose a tenant, or even worse, have to evict.
Look at the loan balances on car loans when checking credit. How difficult will it be for this person to keep the car, the apartment, and the job? That is an important consideration. After all, employers value long-term employees and landlords value long-term tenants.
By Robert L. Cain