Are Car Loans The Next Lending Boondoggle?

Car loans are easy to get but mortgages are tight, at least according to a lot of chatter and complaint. But how can that be when money is money, home values are generally rising and unless you own a rare model collectible cars are a depreciating asset?

“Easy lending standards have helped set post-recession records for new-car sales,” says The Wall Street Journal. “New home building is barely rising, due in part to much tighter standards among mortgage lenders.”

Actually, the better point is that mortgage loans are readily available at cheap rates while auto financing is not what it seems.

Not All Loans Are Alike
Mortgage rates have pretty much been clustered around 4.25 percent for much of the year before dipping below 4 percent in October, according to Freddie Mac.

Mortgage loans are not only cheap they’ve also become a safe, boring, regulated financial products that are getting easier and easier to get. Ellie Mae says the typical mortgage borrower had a 727 credit score in August, down from 743 in May 2013. Indeed, Ellie Mae says that 32 percent of the loans closed in August had credit scores below 700.

Meanwhile, car buyers can get financing in the time it takes to fix a flat. Whether that financing is desirable or not is an open question.

According to The New York Times, car buyers across the country are “easily obtaining auto loans from used-car dealers, including some who fabricate or ignore borrowers’ abilities to repay. The loans often come with terms that take advantage of the most desperate, least financially sophisticated customers. The surge in lending and the lack of caution resemble the frenzied subprime  mortgage market before its implosion set off the 2008 financial crisis.”

So here we go again. Just like the housing market before the bust, easy loans are flooding the auto marketplace and the inevitable result will be a lot of repos as well as huge damage to the economy. A study by the Times found that some subprime auto loans had 23-percent interest rates and principal amounts that were twice the value of the car being  financed. This is like getting a $400,000 mortgage to buy a $200,000 home.

The Lack of Regulation
So where is the Consumer Financial Protection Bureau when we need it?

When the Wall Street Reform legislation was passed in 2010 there was a special exemption for car dealers, a “carve out” which says auto loans offered by dealers are not under the jurisdiction of the consumer agency.

According to the Center for Responsible Lending, “auto dealers frequently add interest rate mark-ups to put car buyers in higher priced loans than the buyers qualify for to increase their own compensation. These mark-ups cost consumers as much as $20 billion each year.”

The Center points out that “auto dealers are lenders. When a family gets a car and financing for the car from an auto dealer, the dealer acts as a lender or broker (or, more commonly, both). The dealer ‘sells’ the financing, and negotiates the price, term and structure of the loan, even where the dealer  sells the loan contract to a finance company after it strikes the loan deal with the customer.”

So the “easy” auto financing lauded by The Wall Street Journal turns out to include a thicket of tricks and traps, high costs, bogus loan applications and inadequate regulation.

While auto financing is riddled with iffy loans, real estate borrowers enjoy low rates and safe loans because home sales are slow, cash is abundant and foreclosures are few. The result is that there’s little risk for investors and that’s a big reason for low mortgage rates. According to the Mortgage Bankers Association, at the end of 2013 more than 90 percent of all serious delinquencies were legacy loans, financing originated before 2009 and the new standards.

The argument can be made that a subprime auto financing crash won’t have the same financial impact as the mortgage crisis because car loans are about one-tenth the size of the mortgage marketplace. This is an idea which is both true and fundamentally misleading: It’s true that at the end of the second quarter auto debt amounted to $910 billion while mortgage debt totaled $9.4 trillion.

The catch is that there’s a multiplier effect. When a borrower loses a car it’s suddenly tough to get to work or school because life in car-based communities becomes difficult-if-not-impossible. The result is that an unpaid auto loan too often leads to lost jobs, lower household incomes and missing mortgage payments.

In fact, to make sure borrowers understand the value of prompt auto loan repayments, some lenders actually require borrowers to install remote cut-off devices: Miss your payment and the car doesn’t run.

Maybe it’s time to have a “carve-in,” to get auto loans regulated and secure so that like mortgages they can become boring, predictable, cheap and less subject to abuse.

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