Auto loans: Rising late payments and defaults have some worried for the economy

Here is a spooky financial scenario: over seven million Americans are more than three months behind on their loan payments. Some owe much more than the asset is actually worth. And many of those loans are “subprime,” taken out by borrowers with poor credit.

Sound familiar? No, it’s not the housing crisis of more than a decade ago—it’s auto loans, circa 2020. And it’s making some economists very nervous indeed.

“There are a few things that are worrying: The amount being financed, the shoddy underwriting for consumers with weaker credit, and the negative equity being rolled over from one loan to the next,” says Greg McBride, chief financial analyst for personal finance website Bankrate.com.

“We’ve seen this movie before on the mortgage side—and it didn’t end well.”

So what’s going on? While headline economic numbers like stock-market averages have been faring well, and the wealth of the 1% has been ballooning by trillions, lower-income Americans are suffering—and it’s showing up in their car loans.

We haven’t heard much about these loans, since many politicians and activists are focused on other kinds of debt—like student loans, now at a whopping $1.6 trillion, according to the Federal Reserve. But auto loans aren’t far behind: They too have rocketed past a trillion, and now stand at around $1.2 trillion, according to a report by credit agency Experian.

And the condition of those loans is worrisome. Almost 5% of the total auto-loan balance is now more than 90 days delinquent, according to the Household Debt and Credit report from the New York Fed. That’s the highest share since the post-financial crisis days.

The portion of the total that is rising the fastest: “Deep subprime,” or those with credit scores between 300-500. Those debts rose 7.8% year-over-year, according to Experian’s “State of the Automotive Finance Market” report.

“In the mortgage market, the percentage of subprime loans is now very low,” says David Musto, a finance professor at the University of Pennsylvania’s Wharton School. “But with car loans, the percentage of subprime is right where we were before—and with a bigger balance. And with longer terms on those loans, it means people are spending longer time in a negative-equity situation.”

Why this is different

But while auto loan delinquencies may be reminiscent of the housing crisis, there are some important distinctions to be made. Though the overall number of Americans facing auto-loan delinquency is at a record high, the percentage of late payers is actually down, since the overall number of auto loans has increased significantly over the years.

And late auto payments aren’t quite as existentially threatening as late house payments.

For context, the size of the auto-loan market is approximately $1.2 trillion—about a tenth of the mortgage market, which stands around $10.3 trillion.
If auto loans start defaulting on a large scale, it will claim a couple of victims: Firstly consumers, who will find it more challenging to get to work and support their families. Secondly, lending institutions—primarily banks (comprising 35.9% of the auto loan market) and captive lenders (subsidiaries of the automakers themselves, with 34.8% of the market), followed by credit unions (19.5%).

Moreover, auto loans haven’t been securitized like mortgages were. So while bad home loans were chopped up and sold to countless investors—meaning the devastation showed up in 401ks and pension plans around the country, creating a nasty domino effect—the pain of bad auto loans is largely restricted to the borrower and the lender.

“Why the mortgage crisis caused so much trouble, was because of who ate that loss,” says Musto. “In the case of auto loans, it is harder for one person’s distress to become another person’s distress.”

Nevertheless, these troublesome numbers are indicative of one thing: Weakness at the lower end of the economy. It means many families are living paycheck to paycheck, and simply can’t meet the obligations of the monthly car note—reminiscent of that oft-cited statistic that 40% of Americans can’t come up with a $400 emergency expense.

A couple of notes for consumers: If you are locked in a high-interest car loan, you do have options. For one thing, with interest rates still so low, another lender might be willing to refinance your loan at a more reasonable rate, says Musto.

Or if you find yourselves in serious financial crisis, because of a medical event or job loss, you might be able to get some temporary forbearance from your lender. This is typically done on an ad-hoc basis, says Musto, and not under official auspices, such as the income-based repayment plan for federal student loans.

Finally, don’t take steps in the wrong direction by continually getting new vehicles and rolling your loans bigger and bigger. Instead, if your old beater still works, keep driving it until the wheels fall off, and that loan is paid off

One thing is sure: If families are falling that far behind on car loans during heady economic times, it doesn’t portend well for when we enter an inevitable slowdown.

“The average amount being financed is $31,000, which means around a $600-a-month payment,” says Bankrate’s McBride. “That is a budget-buster for anyone, and there is no wiggle room.

Adds McBride: “If at some point your paycheck stops, or a two-paycheck household becomes one paycheck, a $600 monthly obligation can cause a real problem, real fast.”