America’s Next Big Rip-Off: Cars Might Be the Next Subprime Crisis!
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If you have bad credit in America, you will have lots of trouble buying a house, securing a credit card or even getting a job. But it apparently won’t stop you from one very expensive but common purchase: buying a car. And now this may augur some serious problems.
Subprime auto loans – given to people with credit scores of less than 680 – account for 27 percent of all loans for new vehicles in 2013, according to analyst Experian Automotive. That’s well above pre-recession levels. Financial firms have pushed strongly into auto loansof late, and are increasingly willing to fund subprime borrowers. This year, banks even sold $17.2 billion in auto loan-backed securities, which are bonds similar to the mortgage-backed securities that accelerated the housing bubble.
In many parts of the country without viable mass transit options, Americans need cars for transportation to jobs or schooling. And surging car sales, now at their highest pace since 2007, helps the broader economy. So an increase in auto loans isn’t necessarily bad. But when all the growth in lending comes from subprime borrowers, who are vulnerable to greedy financiers by virtue of their sheer desperation, experts get nervous.
“The question is whether it’s predatory, and where you draw the line,” says Stuart Rossman, director of litigation for the National Consumer Law Center. His organization and others have found multiple ways in which auto dealers scam subprime borrowers, forcing them into higher interest rates and longer-term loans. Auto dealers, the middlemen between a consumer with bad credit and the financing for the vehicle, have outsize power to set terms and extract profits. And though the Consumer Financial Protection Bureau is supposed to protect Americans from this kind of mistreatment, there’s a catch: Congress carved out an exemption from CFPB regulation for auto dealers, putting their oversight in the hands of the notoriously sclerotic Federal Trade Commission. As a result, just as water inevitably rolls downstream, big money has flooded into auto loans, the financial transactions with the fewest eyes on them.
Dealers obtained this power through a combination of bad regulatory decisions and rising political influence. Decades ago, each major auto company had its own dedicated financing arm; Ford dealers would have to use Ford Credit, GM dealers would use GMAC. The Justice Department’s anti-trust division, in an attempt to drive competition, ruled in the 1960s that automakers could no longer tie financing to the sale of the car. But this gave lots of leverage to auto dealers, who could now pick and choose whom they used to finance their loans. “They shop for the financing company that gives them the best markup,” Stuart Rossman told Salon.
The “markup” refers to the additional points a dealer adds to the interest rate, as compensation for matching the borrower with a lender. This markup is both completely at the dealer’s discretion, and hidden from the borrower. When an auto dealer tells you, “I can get you a loan at 10 percent,” he is not required by law to inform you how much of that reflects the actual cost of financing and how much comprises the markup. In the mid-1970s, the Federal Reserve ruled that dealers could satisfy the Truth in Lending Act merely by quoting the final interest rate to consumers, not the component parts. “They said consumers would be confused,” Rossman said. “But if I knew my dealer was charging me an extra 3 points, I would not be confused about my response.”
Dealers use this opaque system to their advantage, saving their biggest markups for subprime borrowers, who may not otherwise be able to secure credit. They have also elongated the length of auto loans to as much as seven years, which lowers the monthly payment but costs much more in interest – and increases the dealer markup, which gets calculated as a portion of the interest rate. Dealers don’t care whether the borrower can ultimately pay back the loan, because the finance company pays out their markup immediately. The higher interest rates have led to increased defaults on auto loans, years into the recovery.