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Subprime Auto Loans Are More Stable Than Hedge Funds Expect

Monday, February 27, 2017 7:40
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(Before It's News)

There’s an ongoing trend in auto loans that has some experts worried. Car sales have been ticking upward for the past few years. Along with them, car loans have been surging as well. According to the Federal Reserve Bank of New York, car loans stood at $1.1 trillion at the start of 2016.

Better sales and higher borrowing isn’t really an issue, but a growth in delinquency seems to have some experts worried. The Fed pointed out that nearly 6 million people have now defaulted (stopped paying) their car loans. From hedge funds to John Oliver, everyone seems to be drawing comparisons to the subprime mortgage crisis that plunged the world into a financial meltdown in the late-2000’s.

The rate of delinquencies on car loans is drawing the most attention from hedge funds and financial experts. Delinquency rates hiot 3.6% in 2016, and there’s a chance this rate could be higher for the subprime category. According to research by Fitch, the delinquency rate for subprime car loans is the highest it has been since October 1996. 

But there’s an important distinction missed out in this debate – cars are not houses. The foreclosure process on a mortgage default is strikingly different from the recovery process of a delinquent car loan. Depending on the state the foreclosure on a house could take anywhere from six months in Arizona to nearly three years in New York. By the time the foreclosure process is completed, the house loses value which complicates the financial decisions to invest in property.

The result is a deeper loss for mortgage lenders and a magnified impact on the financial system.

However, cars are seized immediately if the interest payments on the loan stop. Repossession is boosted by technology, as street cameras and even drones are used to track down car number plates. Cars are also easier to reclaim and resell. This means the impact on the financial system is limited. The asset doesn’t lose much value and is quickly resold so the lender can limit the losses.

Another reason for the relative stability of the industry is the level of diversification in the car loan sector. Unlike mortgages, car loans are distributed by a number of institutions. Car buyers have a variety of different financing options to pick from when planning their purchase. The auto loan industry is divided up between credit unions, captive auto finance companies, dealers, monoline financiers, independent financiers, and banks. There’s no question of a ‘too big to fail’ scenario in auto loans.

The auto loan sector seems more resilient than the mortgage sector before the financial meltdown in 2008. Fitch Research expects the situation to improve once the tax refunds kick in. The recent run up in debt is part of a natural business cycle for the industry. Even with higher delinquency rates the worst outcome would probably be a glut of used cars on sale for willing buyers.

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