Growth in subprime auto market similar to pre-meltdown mortgage market before Great Recession

Growth in the subprime auto market is raising concerns that lending practices are leading to conditions that risk causing serious problems in the larger auto market.

A report from the Center for Responsible Lending, "Reckless Driving: The Implications of Recent Subprime Auto Finance Growth," highlights trends in the $870 billion auto lending sector, particularly loans to consumers with below prime credit.

The report questions whether auto loans are performing better than mortgages did in the period before the mortgage meltdown, and whether increases in delinquency and default rates signal larger problems in the market.

“Underwriting standards in the subprime market have deteriorated, while practices in the market, like interest rate markup and the sale of add-on products, can make loans unaffordable,” said Chris Kukla, senior vice president for the center and one of the authors of the report. “Our analysis shows that when the quick speed of car repossessions and home foreclosures are compared, current delinquency and repossession rates are higher than foreclosure rates in the mortgage market.”

These trends suggest there are systemic issues in the subprime auto lending market, Kukla said.

The center estimates that if car repossessions took as long as foreclosures, the equivalent auto repossession rate would be 7.41 percent. The current home foreclosure rate is 2.65 percent.

Other findings in the report:

• The subprime car market has mushroomed, with the dollar value of loan originations to people with subprime credit doubling since 2009. Subprime loans account for $336 billion in car loans—38.7 percent of all loans.

• Car repossession rates have climbed in the last four quarters. The second quarter 2014 repossession rate was 70 percent higher than the second quarter 2013 rate.

• Lenders are loosening underwriting standards and extending loan terms to as long as 96 months while increasing auto loan amounts, thereby increasing the risk of defaults, especially for subprime auto loans. While the monthly payment for the average subprime loan is only 8.7 percent higher than for a super prime loan, the interest paid by the average borrower is over 400 percent more.
• Dealer interest rate markups and selling and financing add-on products exacerbate the risk of default and increase risk disproportionately for borrowers of color.