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Beware Auto Dealers Bearing Gifts: The New Subprime Loan Crisis

Less than 10 years ago, the subprime mortgage lending crisis sent the economy into a tailspin.  Now, a new predatory lending practice has come to the forefront of financial and consumer concerns and has many of the same issues and risks as the mortgage crisis—used car loans at exorbitant rates to consumers with credit scores of 640 or below, also known as subprime auto loans.

There is a proliferation of used automobile dealerships advertising “No credit? Bad credit? No problem!” in an attempt to entice consumers who may not otherwise qualify for, and may not be able to afford, a used car loan.  These dealerships target potential purchasers with credit scores of 640 and below.  In exchange for offering credit to higher risk consumers, the banks financing these loans charge very high interest rates in comparison to those offered to potential purchasers with more favorable credit scores.  Occasionally, dealerships fabricate work history or income to ensure that a consumer qualifies for a loan.  In other circumstances, the dealerships and banks offer loans to consumers they should know do not have the ability to pay back.  In many cases, providing these high interest loans simply sets up car purchasers for failure with monthly payments they are realistically unable to afford.

Owners of vehicles financed through subprime auto loans do their best to make their payments, but often, unfortunately, the high interest rate combined with the large monthly payments lead to an inability to pay.  In some cases, after missed payments, the bank repossesses the vehicles. In other cases, even if the payment is a mere few days late, the bank utilizes remote starter interrupters that render the vehicles unable to start until the balance owed is paid.  This leaves consumers with no way to transport themselves and their families, even in the event of an emergency, or to travel to and from work.  Unfortunately, this often leads to even greater financial woes.

In addition to harming consumers, these subprime loans can harm the economy as a whole.  Like subprime mortgage loans, subprime auto loans are packaged as security offerings and sold to investors.  Often, the true risk of these investments is hidden from or misrepresented to investors who purchase these security packages.  In the past several months, investors have filed securities fraud class actions against banks that issue these loans for failing to adequately disclose their risk and for questionable underwriting practices.  Additionally, the Department of Justice has begun a criminal investigation into Santander Consumer USA’s and other banks’ practices in underwriting and issuing subprime auto loan-backed securities.

There are many resources available to help potential car buyers determine if a loan they are offered fits into their budget.  Use free budget trackers such as Mint.com.  These budget trackers can link to your bank accounts and credit and debit cards and tell you how much money you spend on a weekly, monthly, even yearly basis.  You can use this data to determine if you can afford the monthly payments you are being offered.  You can also purchase budget and finance applications for your phone or computer for additional functionality.  This Web site has a good summary of the pluses and minuses of a variety of these applications.  Don’t have access to a smartphone or home computer?  Use your bank statements, pay stubs, and credit card statements to plot out your budget and spending habits at home on paper.

When you decide on a car to purchase, put down as much money as you afford when you buy your vehicle, this will also help lower your payments.  Do not rely on representations by the bank or the car dealer that your payments will lower if you make regular payments.  Make sure you can afford the monthly payments for the duration of the loan.  If possible, utilize a shorter loan term.  If you can afford it, this will save you money over the duration of the loan.  Finally, beware deals that seem too good to be true, they often are.