In October I wrote to you about how the auto industry is recovering. A big part of that recovery is due to the fact that many more people are getting loans, even though they have less than perfect credit. In fact, those who are getting loans often have downright poor credit. However, with the economy picking up, and banks being more willing to lend, more people with bad credit are able to drive away in a new car.
One reason that people are able to buy a new car, despite having bad credit, is the fact that they have a well paying job. Many people lost their jobs during the recession. Then, during the course of the next few years, they lost their house, missed credit card payments, and various other circumstances resulted in low credit scores. Now, these same people have a new job that pays well, and they can afford to make car payments. But the damage has been done to their credit scores, and when analyzed it still shows that they are a higher risk of default. With banks making more profits, and being able to take on more risk, they are getting looser with their lending. They are more willing to give loans to these higher risk borrowers because of the fact that they can indeed make the payments. The real problem is that they simply have not had enough time to build their credit scores back up to where they should be.
A big difference between a home price and a car price is the fact that a car is much easier to value. Houses have an arbitrary value assigned to them. A home in one area of the country could be worth double or triple what it would be worth in another area. Vehicles, on the other hand, are more stable in their pricing. There is not a large fluctuation due to locality. By being easier to value, the risk associated with the lending process is easier to calculate. Therefore, those issuing the subprime auto loans are more likely to give a loan to a high risk borrower since they know exactly what they are getting into.
While nobody wants to get kicked out of their home, and a foreclosure is the last thing on most people’s to-do list, it does actually happen. And when foreclosed, renting is always an option that is not terribly difficult to do. However, losing your vehicle is another story. People need their cars to get to work, so when faced with tough choices on what to cut from their budget, they rarely cut their car payment. This means that when it comes down to it, they sacrifice in order to make sure that their car is paid as they would rather not resort to taking the bus to work (if that is even an option).
Subprime loans are nothing new, they have been around for years and they will persist for many more years into the future. And there is nothing wrong with a subprime loan, it is simply one given to someone that is a little higher risk of defaulting. With so many people out there that have the earnings capacity to buy a car, but not the credit history (or have had credit bumps along the way) to be eligible for a subprime auto loan. At least not until now; now they can walk into a dealership and drive away with a vehicle that will last them for many years to come. In the meantime they will be building their credit back up, so if a time comes when lending is tightened again, they will not have a problem.
This article was first published on http://moneyprime.com.