Risky Loans at Used Car Lots
Robert Menard
Certified Purchasing Professional,
Certified Professional Purchasing Consultant, Certified Green Purchasing Professional, Certified Professional Purchasing Manager
In my online course on How to Buy a New or Used Car and Save Thousands published in 2012, we stressed the mandates of a good credit score and financial literacy. A New York Times (Times) syndicated story dated 21 July 2014 authored by Jessica Silver-Greenberg and Michael Corkery, cited risky loans at used car lots as the subprime mess of our day. In the opening, the authors relate the tale of a 60 year old man who stopped working decades ago and whose only source of income is Social Security. Yet Wells Fargo lent him more than $15,000 to buy a used Mitsubishi.
According to the Times story, Durham’s loan app said that he earned more than $35,000 per year as a technician at a hospital in Binghamton, NY. However, Durham claims that he has not worked at that hospital for more than 30 years yet Wells Fargo is pursuing payment and has repossessed the car.
The Times story refers to Durham as one of millions of Americans with shoddy credit who seem to have no trouble easily obtaining credit from used car dealers. The story blames used car dealers with falsifying the applications.
In what the Times terms “explosive growth”, the risky used car loan market resembles the dynamics at work in the failure of the subprime housing mortgages of a few years ago. Willing investors have been pouring money into the financing in return for ultra-high interest rates and profits.
The pattern continues
The subprime auto loans are bundled into complex bond packages and sold as “securities”, a la the subprime mortgages. Buyers of these “securities” include banks, insurance companies, mutual funds, and public pension funds. This buying activity stimulates spinoff interest from non-institutional buyers which in turn drives up demand.
A Times investigation of related bankruptcy cases found that, “…dozens of civil suits against lenders involving hundreds of loan documents” revealed that subprime loans often came with interest rates above 23%. A normal good credit borrower qualifies for a rate of less than 3% in today’s market. The loans typically financed more than twice the value of the used car being purchased and including dozens of vehicles with mechanical defects that were concealed from the borrowers.
While these facts are offensive on their face, how disheartening and vile is it that lesser advantaged buyers are exploited by unscrupulous sellers? This is ironically called the high cost of poverty. The only solution is education and training.
In the online car course on, I take pains to demonstrate the importance of credit and how finance functions. Those who are not minor experts in economics are easy prey for shady operators. For many of these people, the only salvation is consumer law, but that usually arrives too late.
Don’t become a victim
The Times drew a parallel of the auto finance scandal to the subprime mortgage meltdown. The auto loans are but a fraction of the mortgages but fraud and criminality appear in both. Some bank analysts and credit agencies that have profited by these high rate risky loans are mending their ways.
Typically, these loans have balances that exceed the car’s value and longer payment periods. A report issued by Standard & Poors cautioned investors to expect higher losses in the subprime auto loan market. Despite such warnings, however, the total of such loans increased by 15% to $145.6 billion in the first three months of 2014 compared to the same period in 2013 according to Experian.
The arguments for and against these subprime loans are familiar. The lenders insist they provide a service to borrowers with tarnished credit who would otherwise be unable to procure transportation and pursue a livelihood. Investors point out that the higher risk is justified by the risk but the story is silent on the tawdry practice of bundling and reselling in “security packages”.
The story suggest that low income Americans are the victims of these loans and recites interviews with legal aid lawyers, Federal Trade Commission, Consumer Financial Protection Bureau , and state prosecutors.
I believe that this subprime practice is a shameful fleecing of an uneducated and unsophisticated struggling economic class. We can however make sure that we never make these same mistakes.