Auto Loans and Easy Credit
How would you like to buy a brand-new 2015 Ford Mustang and pay no interest on a six-year loan? Well, a number of Labor Day sales events have made this type of deal a reality.
Of course, not everyone will qualify. Don’t expect to pay 0% interest unless you have a near-perfect credit score. According to Experian, the average interest rate for new vehicle financings was around 4.7% in the first quarter of 2015.
Ironically, the people who would qualify for a no-interest loan probably don’t need to borrow to buy a car in the first place. Most Americans, though, don’t have the cash to plunk down for a car, so they’re taking advantage of low interest rates and easy credit conditions to finance the purchase.
In fact, many alarming vehicle financing trends have raised concerns that we’re in the midst of an auto loan bubble.
Outstanding U.S. auto loan balances have increased by over 43% since the second quarter of 2010 and have now reached $1 trillion for the first time ever. The second quarter of 2015 saw the fastest aggregate auto loan growth since 2005.
The average duration of new auto loans has also lengthened considerably in the past few years. Recently, loans with terms lasting 73 to 84 months accounted for a record 29.5% of all vehicle financings.
Clearly, the economy isn’t rock solid if so many consumers have to extend the duration of their auto loans just to afford the monthly payments.
Another worrisome sign is loosening credit standards. According to Experian, 28% of new auto loans were rated nonprime, subprime, or deep subprime in the first quarter of 2015. That’s up from 24.6% in the first quarter of 2013.
Subprime auto loans allow over-indebted consumers to buy a car that they otherwise couldn’t afford and become even more indebted. And in case you were wondering why auto sales are at 10-year highs… All you need is a pulse to get an auto loan.
Feeding the Debt Addiction
Meanwhile, institutional investors reaching for yield are vacuuming up highly rated debt tranches collateralized by subprime auto loans, allowing for even more subprime loan origination. This is reminiscent of the activities in the subprime mortgage market leading up to the apex of the housing bubble.
To be sure, the auto loan market is only a fraction of the size of the mortgage market. Thus, we’re not talking about a problem that threatens systemic collapse. Plus, delinquency rates are still relatively low. Only 3.4% of auto loan balances were 90 or more days delinquent in the second quarter of 2015.
The delinquency rate for student loans, which eclipsed $1 trillion in outstanding debt in 2013, is far more concerning at 11.5%.
However, the disturbing trends in auto lending shouldn’t be downplayed.
Compared with a mortgage, debt used to finance a car purchase is extremely unproductive because cars are rapidly depreciating assets. And during the next recession, expect auto loan delinquencies to surge and stay elevated for quite some time.
The growing reliance on auto financing shows that our ongoing debt addiction continues. Total household debt-to-GDP is currently around 77%. That’s down from a high of roughly 96%, but still well above the 45% seen in the early ‘80s.
The next U.S. recession will likely be triggered by problems with the global economy, which is showing serious signs of stress. The U.S. economy is made far more fragile by consumers overextending themselves on auto loans – and that means this global downturn will be painful.
Safe (and high-yield) investing,
Alan Gula, CFA