The Ongoing Subprime Auto Loan Love Affair

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Since the recession began most people have experienced a drastic tightening of belts. For many, life still moves on and the necessary expenses and purchases in life must still be made—even if they must be made more frugally. With a frugal attitude in mind, many consumers have opted to purchase used vehicles instead of new vehicles. Thanks to the internet, prudent borrowers can now perform due diligence and research on auto loans needed to make vehicle purchases. This common sense and practical attitude has led to a striking trend involving auto loan lenders.

According to an Experian report, subprime borrowers received 56.46 percent of loans for used cars in the second quarter of 2012. This is an increase from 52.70 percent one year ago, arguably when the economy was worse off than it is today.

Concerning new vehicles, subprime borrowers have received 25.41 percent of all new auto loans. This is a noted rise from 22.29 percent in the same quarter last year.

A closer evaluation of subprime auto loan customers is necessary in order to understand this upward trend.

Subprime Focus

From a bank’s point of view, subprime customers may be proverbial diamonds in the rough.

As many people—and banks—well remember, the financial bubble resulted in the insolvency and collapse of several banks and financial firms. Worse still, the housing bubble explosion led to mass defaults, which, in turn, meant that many banks stopped receiving monthly payments on their lent money. Once many borrowers stopped making their monthly mortgage payments, banks and lenders resorted to their only remaining option: they foreclosed on homes.

Banks then faced the difficulty of selling reduced value homes in a recession.

But fortunately for banks and other lenders, there's an easier product to sell. People still need—and will always need—transportation. At least until teleportation is invented.

People need vehicles to get to school, interviews, and jobs. Schools and colleges provide people with the education necessary to secure future employment. Interviews give people a chance at being employed. Finally, jobs give people the money necessary for rent, utilities, disposable purchasing power, and necessities. To put it bluntly, vehicles are a necessity themselves in our society.

Lenders realize this and have simply begun focusing on subprime auto loan borrowers. Fortunately for both lenders and borrowers, the recession and weak economy have bolstered the number of subprime customers across the country since many people have survived these troubling economic times at the expense of their credit scores.

Bank managers and other lenders are pressured to compensate for lost profits that came from a weak economy, and, in order to answer that pressure, they’ve begun loosening their auto lending standards and have begun issuing more and more subprime car loans.

Cautious Numbers

In the second quarter of 2012, outstanding car loans totaled $682 billion, which was less than the $701 billion in 2007—the year of the financial crisis.

Melinda Zabritski, director of automotive credit at Experian, expressed that auto loan lenders were being cautious on how much they lend against the value of new vehicles. The average loan-to-value ratio on new vehicles was 109.55 percent, having fallen 0.61 percentage points from 2011.

“Despite the rise in subprime loans overall, there is still a strong sense of managing risk. Because the overall lending environment has improved, lenders are making loans available to a wider range of customers,” said Zabritski in a Reuters interview.

Clearly some of these customers are subprime borrowers. The average loan-to-value ratio for used vehicles jumped up 0.62 percentage points from last year to 126.62. In comparison, the average amount lent on new auto loans rose to $25,714, which is an increase of $474 from last year’s figure. The average for used cars rose to $17,433, which is up $370 from last year.

The average time it took to repay both new and used auto loans rose by one month, up to 64 months and 60 months respectively.

Since vehicles are so vital to the lives of borrowers, lenders can rely upon steady loan payments. Funds are prioritized for auto loan payments even ahead of mortgage and credit card payments. The percentage of delinquent loans past 30 days due fell from 2.59 percent to 2.52 percent in the second quarter of 2012.

According to Experian’s analysis, Capital One saw a two-fold increase in the amount of new car loans lent.

In contrast to this Ally Financial, a government-owned lender, saw a market share decrease from 6.93 percent to 6.68 percent in 2011. Ally is owned by General Motors and currently faces an expiration of preferred lending arrangements with GM and Chrysler Group LLC in which the two car manufacturing giants subsidize zero-interest auto loans. Once these lending arrangements expire, Ally would be wise to implement higher interest financing that can help generate profit.

Time will if the subprime financing trend continues as lenders keep up their infatuation with auto loans amid fewer profitable lending opportunities.