A record 7 million Americans are 90 days or more behind on their auto loan payments, the Federal Reserve Bank of New York reported Tuesday, even more than during the wake of the financial crisis.
“The substantial and growing number of distressed borrowers suggests that not all Americans have benefited from the strong labor market,” economists at the New York Fed wrote in a blog post.
A car loan is typically the first payment people make because a vehicle is critical to getting to work, and someone can live in a car if all else fails. When car loan delinquencies rise, it is usually a sign of significant duress among low-income and working-class Americans.
“Your car loan is your No. 1 priority in terms of payment,” said Michael Taiano, a senior director at Fitch Ratings. “If you don’t have a car, you can’t get back and forth to work in a lot of areas of the country. A car is usually a higher-priority payment than a home mortgage or rent.”
People who are three months or more behind on their car payments often lose their vehicle, making it even more difficult to get to work, the doctor’s office or other critical places.
The New York Fed said that there were over a million more “troubled borrowers” at the end of 2018 than there were in 2010, when unemployment hit 10 percent and the auto loan delinquency rate peaked. Today, unemployment is 4 percent and job openings are at an all-time high, yet a significant number of people cannot pay their car loan.
Most of the people who are behind on their bills have low credit scores and are under age 30, suggesting young people are having a difficult time paying for their cars and their student loans at the same time.
Auto loans surged in the past several years as car sales skyrocketed, hitting a record high in 2016 of 17.5 million vehicles sold in the United States. Overall, many borrowers have strong credit scores and repay their loans on time, but defaults have been high among “subprime” borrowers with credit scores under 620 on an 850-point scale.
The share of auto loan borrowers who were three months behind on their payments peaked at 5.3 percent in late 2010. The share is slightly lower now — 4.5 percent — because the total number of borrowers has risen so much in the past several years. Still, economists are concerned because the number of people impacted is far greater now and the rate has been climbing steadily since 2016 even as more people found employment.
Experts warn Americans to be careful where they get their auto loan. Traditional banks and credit unions have much smaller default rates than “auto finance” companies such as the “buy here, pay here” places on some car lots.
Fewer than 1 percent of auto loans issued by credit unions are 90 days or more late, compared with 6.5 percent of loans issued by auto finance companies.
“The No. 1 piece of advice I have is to not get your financing from a car dealership,” said Christopher Peterson, a law professor at the University of Utah and former special adviser to the Consumer Financial Protection Bureau. “Shop separately for the vehicle and the financing. Go to a credit union or community bank to get a low-cost loan.”
Rates can vary substantially depending on a borrower’s credit score and where they obtain a loan. A “prime” borrower with a credit score in the range of 661 to 780 can get an auto loan rate of about 4.5 to 6 percent, according to NerdWallet. In contrast, a subprime borrower is typically looking at rates between 14.5 and 20 percent.
After the financial crisis, the government placed heavy restrictions on mortgages to make it harder to take out a home loan unless someone could clearly afford to make the monthly payments. But experts warn that there are far fewer restrictions on auto loans, meaning a consumer has to be savvier about what they are doing when they take out a loan.
"Predatory lending practices and a lack of real transportation options leave many households trapped in debt with few ways out,” said Faye Park, president of the U.S. Public Interest Research Group, which advocates for consumer protections.
Repossessing a car is also a quick process thanks to technology and the laws in many states. Some cars are installed with devices that prevent the car from turning on if someone misses a payment and it has become easier to geo-locate a car to tow it away.
“It’s a lot easier to repossess a vehicle than to foreclose on a home,” Taiano said.
He noted that non-prime and subprime auto loans increased from 28 percent of the market in 2009 to 39 percent in 2015, a reminder of how aggressively lenders went after borrowers who were on the margin of being able to pay. More lenders are giving people six or seven years to repay now vs. four of five years in the past, according to Experian, another tactic to try to make loans look affordable that might not otherwise be.
While defaults on auto loans are a red flag, they are unlikely to take down the entire financial system as mortgages did in the lead-up to the 2008-2009 financial crisis. The total auto loan market is just over $1 trillion, far smaller than the $9 trillion home mortgage market.
The amount of money people borrow to buy a car is also much smaller — typically under $35,000 — vs. a home loan, where people often borrow several hundred thousand dollars.
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This article was updated to clarify that the highest credit score is 850.