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Subprime Loans Are Back—and Riskier Than You May Think

One obvious lesson that the financial crisis is trying to teach is lending to borrowers with poor credit entails big risks. But investors did not take heed. Subprime loans are back now in the context of auto loans.

The Federal Reserve Bank of New York sees subprime auto lending going back to pre-crisis levels. The most recent report from the credit bureau TransUnion shows that 33.8 percent of new auto loans went to people with credit scores that are below 700 in the third quarter. It’s higher than the 32.6 percent record last year and quite near 38.04 percent in the second quarter of 2007 during the Great Recession.

Moreover, about $17.2 billion worth of bonds backed by subprime auto loans were issued this year, which is still short of $20 billion in 2005.

subprime auto lenders

Lenders have more power when a subprime borrower becomes delinquent in his car loan. They can immediately take the car back which they can’t do in a mortgage, student loan and credit card. Also, auto loans are not regulated by the Consumer Financial Protection Bureau.

The TransUnion report also shows that the rate of borrowers who are 60 days or late or longer in their payments went up to 5.6 percent in the third quarter, slightly higher than 5.3 percent last year but still lower than 6.59 percent in 2009. Loan delinquency rates have been steady since 2009 even if more subprime borrowers these days get approved for auto loans.

Even if TransUnion’s Peter Turek, the vice president of automotive, said that “auto delinquencies aren’t a significant risk,” consumer advocates say that the risks of subprime auto loans are great especially to consumers, which the regulators are overlooking.

According to a TransUnion survey, borrowers are now prioritizing their car payments than their credit cards and mortgage. Chris Kukla, vice president of Center for Responsible Lending (CRL), said that this “masks the real delinquency rate of car loans.” He noted that the rate is likely to be higher because lenders can repossess the car more easily than other types of collateral, and when they do, the borrower is no longer delinquent.

Subprime borrowers pay more interest on loans as they naturally receive higher interest rates because of their spotty credit. But dealers can make the payments more burdensome by marking up the interest rate of the auto loan they are arranging for car buyers. In a 2009 study, the CRL found that an auto loan interest rate markup costs a consumer around $714 on average. All these leave borrowers with limited negotiating power.

While investors see an opportunity to make more money in the lucrative subprime market, auto loans that go there are riskier than they may look.

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