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TransUnion: Longer Term Auto Loans Increase Odds of Default

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Consumer credit reporting agency sees increased risk of default on some loans.

Easy credit has hurt consumers before and the current credit underwriting climate is no exception. A study conducted by the credit reporting agency TransUnion found the average auto loan term has expanded from 62 months in 2010 to 67 months in 2015.

TransUnion discovered that seven of 10 new auto loans had terms longer than 60 months, up from about half of all loans in 2015 (as of the third quarter of 2015 (July-September)). The agency also found the length of time a consumer keeps a loan and such loans remain in a lender’s portfolio has, in fact, declined.

What accounts for the discrepancy? It’s quite simple — more consumers are refinancing their car loans. This means original lenders are losing customers to refinancers. At the same time, consumers are extending their overall payment terms in an effort to afford their cars — one long-term loan becomes a refinanced long for a super-extended auto loan.

Longer Term Auto Loans

falling moneyThe TransUnion study determined that car loan terms between 73 and 84 months have more than doubled between 2010 and 2015. Indeed, one-quarter of all loans originated in the third quarter of 2015 were for loan terms between 73 and 84 months, compared to just 10 percent five years earlier.

Another factor the TransUnion researchers noted that even as average new auto loan amounts increased during the five-year period, the average monthly payment declined as consumers chose the extended loan terms.

For example, in the third quarter of 2015, the average new auto loan amount was $21,368, compared to $18,008 five years earlier. At the same time, the average new auto loan payment had fallen to $398 per month from $420 per month five years earlier.

Smaller monthly payments should help consumers afford their loans, but TransUnion found that consumers holding longer loans are more likely to fall behind on their payments by at least 60 days (seriously delinquent) than those with shorter terms. And it wasn’t just sub-prime borrowers who were delinquent at a greater rate — the trend affected prime and super prime borrowers as well.

Mitigating Auto Loan Risk

Jason Laky, senior vice president and automotive business leader for TransUnion, noted, “Longer auto loan terms allow consumers to keep payment levels reasonable as they finance more expensive vehicles. However, consumers who cannot afford the monthly payment on a shorter term for the same loan are riskier, and we see this manifested in the higher delinquency rates for 72- and 84-month loans. We encourage lenders to use readily available risk analysis tools to identify borrowers who are more likely to go delinquent with an extended term, to ensure consumers are receiving loans that they can manage.”

For consumers with sufficient cash flow, the risk of a longer term auto loan defaulting diminishes according to TransUnion. Thus, the credit reporting agency urges lenders to carefully explore all applicant debt when underwriting, including mortgages, credit card payments, student loans, and other debt commitment. In effect, an “aggregate excess payment” or (AEP) algorithm is useful for helping lenders determine lending risk and make their decisions accordingly.

As for consumers, affording a new car may mean much longer auto loan payments, going well beyond the original loan term all in an effort to purchase beyond their capabilities.

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Subprime Auto Lending Bubble? Not So, Says Equifax

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Bad credit car loans: what is the risk?

Within the next few days, you will learn that August 2014 auto sales were once again robust. The US market is not yet at its apex, but it certainly is far removed from the dismal 10.4 million vehicle sales of 2009. When the year ends we should find a market with more than 16.5 million units sold.

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Subprime Auto Loans

Fueling the sales increase are loans to millions of buyers that might otherwise not afford a new car without some easing of lending rules. These consumers do not have good credit, but their credit may still meet minimal lending requirements. For people with sub-standard credit and in need of a new car, the credit “easing” is certainly a welcome move.

Some media analysts, however, are worried that a subprime auto lending bubble is forming, similar to the housing bubble that caused the market to tumble in 2008, ushering in the Great Recession.

The New York Times Investigates

In July, the New York Times ran an article, “In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates,” where reporters took a look at the “new subprime boom” and shared horror stories of consumers who were qualified for auto loans, but eventually had their cars repossessed when they could not keep up with their payments. It was just one of a handful of stories in the past few months that have indicated an auto loan apocalypse may be imminent.

The alarm has been sounded, but not everyone is in agreement with the warning. Late last month the consumer and commercial data company, Equifax, Inc., issued a statement refuting the notion. In its monthly Economics Trend Commentary, two of its experts — Chief Economist Amy Crews Cutts and Deputy Chief Economist Dennis Carlson — arrived at a much different conclusion.

Equifax Consumer Credit Reports

The Equifax team assembled aggregate data derived from credit reports for more than 210 million consumers in the company’s own database. That information assessed the current state of subprime automotive lending with potential economic benefits considered.

The lending landscape today is not the same as it was in 2007 — both because lenders generally have a reduced appetite for risk and because regulatory scrutiny has increased, said Dennis Carlson, Deputy Chief Economist, Equifax. In this Commentary, we discuss why we believe that while the subprime lending segment needs to be monitored carefully the evidence at this time does not suggest there is a bubble forming.

Equifax backed up its claim with a seven-page report that chided the press for making rhetorical arguments without supporting those claims with facts. Further, Equifax defended the market, noting that “a fair and functioning “second-chance market” is necessary for a fully functioning economy.”

Without access to a car many people find it difficult to get a job as well as to get to a job. Moreover, a number of people with subprime credit may have lost their jobs and/or their homes during the Great Recession. Subprime lending allows them to get back on their feet and put their hardships behind them.

Loan Originations and Subprime Share

Equifax supported its claims with charts that underscored several important points, including the number of auto loan originations and the subprime share. That share today is more than 5 points lower than it was in 2007, just ahead of the last recession. Equifax measures subprime lending as a credit score under 640 points.

The percentage of auto loans that are at least 60 days past due comes in at just under 3 percent or slightly lower than the pace set in 2006 and 2007, but above the rate during the recession. Moreover, the loan write off rate is still lower than the years leading up to the Great Recession, demonstrating that defaults are under better control today. You can review a portable document file (pdf) of the report here.

The New York Fed Weighs In

Equifax is not alone in refuting stories of a pending subprime auto lending bubble. Earlier in Aug., Bloomberg Businessweek also examined the New York Times’ claims, then cited the findings of four New York Fed economists who had a different viewpoint. The Fed said, “We do not see evidence supporting a disproportionate or unusual volume of new loans being issued to riskier borrowers.”

A follow up blog article by the Fed on Aug. 14, 2014, did note an increase in subprime lending, but also found an increase in prime auto lending. Thus, the subprime share is “less pronounced” and the threat that some people see as looming still has a long way to go from reaching a tipping point.

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Money Saving Strategies for Auto Loan Shopping

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If you are shopping for a new car, more than likely you will take out an auto loan. Such loans are common to 90 percent of new car buyers, individuals that do not have enough cash on hand to afford a purchase. Auto loan rates vary and can cost you hundreds of extra dollars if you jump in without thinking. Employ several money saving strategies when shopping for an auto loan.

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Don’t break the bank to buy your next car.

Shop for a Loan

Loan rates vary and one lender may offer a half-percent lower than the next. You won’t know this unless you compare offers from at least three lenders. Better yet, consider five or six lenders including your own bank or credit union.

Know that loan rates change based on the length of the loan. For instance, a 48-month auto loan will typically have a lower rate than a 60-month loan. At 72 months, your rate will be higher. Go with the shortest term loan you can manage.

Put More Money Down

Lenders want borrowers to have skin in the game. Although it is possible to swing a “no money down” loan, you will pay for it with a higher interest rate.

When you have money to put down, including much more than the customary five to 20 percent down, then you can ask for a lower interest rate. If you do not get it from one lender, then go on to the next.

Fix Your Credit

Know that advertised auto loan rates are for customers with excellent credit. That means you need to have a credit score of at least 720 to 750 to get the best rate. Lower credit scores mean a higher interest rate.

If your credit is low, especially if it is in subprime territory, then your interest rate will reflect your bad credit. At this point, you night want to put off applying for a loan until your credit improves. Pay your bills on time, clean up your credit reports and avoid opening up new accounts until after you receive your auto loan.

Rebate Versus Loan Rate

So, should you take the generous rebate or should you go with the low-rate dealer financing? That’s both a question and a dilemma customers face and often do not know how to resolve. You can figure out what option is best for you by inputting your information on the Bankrate.com finance calculator.

The best deal for you may be to go with your own financing company and keep the rebate. That rebate or cash back offer can be used toward your down payment, supplementing the contribution you planned to make. For instance, if you planned to put $3,000 down and the rebate is for $2,000, then you only need to finance $20,000 for your $25,000 new car purchase.

Avoid the Extras

When you are preparing to sign your auto loan contract, pay special attention to the fees charged. Everything should be put in writing and fees should not be added after the fact.

Some of the fees you can expect to pay are destination, property tax and your state sales tax. What you may also discover are special dealer prep, department of motor vehicle license delivery and undercoating charges. Such “junk” fees should be eliminated before you sign your sales purchase agreement.

Related Reading — What Your Dealer Won’t Tell You About Car Financing

On the Rise: Subprime Car Loans

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Loosening lending standards – cause for alarm?

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car loanSubprime lending was the bane of the housing market, attracting and pulling in millions of home buyers who otherwise would not have been approved for a loan. These types of loans ended up being a huge problem as such homeowners were unable to handle the higher monthly costs incurred as little to no money was needed for a down payment. Well before the housing market collapsed, these owners were unable to keep up with payments and began to default on their loans.[1]

Subprime Lending

The auto lending industry has its own experience with subprime lending although there are some differences in the way that these loans are written and handled. Subprime lending targets people with poor credit, borrowers who otherwise would not be able to afford a new car loan as offered by the lending arms associated with each manufacturer such as Toyota Credit or TD Auto Finance. Such borrowers typically have a credit score under 620, but the approval rate was as low as 9 percent as recently as 2010.[2]

The trend today, however, is to focus on subprime borrowers with Experian Automotive reporting that the “portion of car loans made to subprime borrowers rose to 40.8 percent in the second quarter” of 2011, up from 37.2 percent a year earlier.[3] Lending standards are loosening although unemployment remains above 9 percent and the U.S. economy appears to be weakening.

Conservative Lending

Although the portion of subprime lending is on the rise, lending standards are still tighter than what they were a few years ago. Conservative lending practices employed in 2009 and 2010 has helped the lending industry to rebalance its portfolios and carefully extend lending to people with less than stellar credit. The industry reports that delinquencies are low and repossessions have also declined, but these numbers may change as the subprime lending market continues to expand.

New car loans rates are below 4 percent for buyers with excellent credit. Zero percent financing and other low-rate financing deals are being marketed right now, but those rates are reserved for people with excellent credit which usually means a credit score above 740.

Cautionary Borrowing

For people with poor credit, subprime loans may be the only way to new car ownership. If you’re in the market to buy, however, consider whether you can weather a change to your personal economic climate (as in a loss of income) before being enticed to buy a vehicle you really cannot afford. Otherwise, a late model used car might be a better option provided the loan rate terms are in the single digits and loan terms are 48 months or less.

References

[1] Federal Reserve Bank of St. Louis Review; The Evolution of the Subprime Mortgage Market; Souphala Chomsisengphet and Anthony Pennington-Cross; January/February 2006

[2] Idaho; (Michigan) GM Takes On Subprime Car Loans, But It’s Less Risky; July 26, 2010

[3] Reuters: U.S. Lenders Making More Subprime Car Loans: Report; August 30, 2011

See Also — TransUnion: Longer Term Auto Loans Increase Odds of Default