House Financial Services Subcommittee Issues Testimony From Frontier Group
"I am a policy analyst at
SCOPE OF PROBLEM
"In much of the country, owning a car is a virtual necessity. It is how you get to work, to the grocery store, and to the doctor. A car, in short, is the price of admission to leading a full, productive life. Owning a car is also expensive. Transportation is the second-leading expenditure for American households, behind only housing.1 Approximately one hour of the average American's working day is spent earning the money needed to pay for the transportation that enables them to get to work in the first place.2 These expenses of car ownership drive millions of households to take on debt.
"Currently, Americans owe more for their cars than they ever have before. The total amount of outstanding auto debt is over
"But it is not only that overall auto debt has reached historic levels - the number of Americans who owe for their cars is also at its highest in
"And consumers are at risk. Delinquencies are rising. The percentage of auto debt that is seriously delinquent - meaning 90 days late or more - is the highest it has been since 2012 and is still climbing. More than 7 million Americans have missed at least three monthly car payments.5
"These numbers are concerning on their own. What makes them deeply troubling is that they are happening in a strong
"Something important has been happening in the auto credit market. Since the Recession, the lending practices that have boosted auto sales have also put the financial well-being of millions of American households at risk.
HOW WE GOT HERE
"In the aftermath of the 2008 financial crash, investors and lenders alike noticed that auto debt performed relatively well during the Recession.7 This - coupled with the federal government's bailout of the auto industry and key lenders - sparked interest across the board in bringing more borrowers into the auto credit market and onto showroom floors.8 Lenders of all types took steps to do so.
"First, lenders loosened standards for prospective borrowers. Immediately following the federal bailout of the auto industry, GMAC publicly stated it would use its bailout funding to offer credit to consumers, lowering the minimum credit score to qualify for financing from 700 down to 621.9 Other lenders followed suit.
"We found in our report that auto debt has risen across all income levels, but it's risen the fastest among those with the lowest incomes. Since 2009, according to data from the
"Lending in the subprime market followed a similar trajectory. During the Recession, subprime lending fell steeply. In 2007, subprime and deep subprime loans accounted for 23 percent of all
"In addition to benefiting from low interest rates, lenders used other tools to bring additional borrowers into the marketplace, including lengthening the terms of auto loans.
"Extending loan terms brings down the monthly payment. In the era of Netflix and other monthly subscription-based services, the monthly payment is an important measure by which many consumers determine affordability. Low-income borrowers are particularly sensitive to changes in loan maturity according to a 2007 study, suggesting that the longer loan terms of recent years may have been an important spur for the rapid rise in auto loans to low-income households.13
"While longer loan terms may reduce the monthly payment amount, they also mean that the consumer will pay more over the life of the loan in interest payments, and will spend more time "underwater" on a car - or owing more for the car than it is worth.
"Whereas a 48-month loan used to be the industry standard, loans of five or more years have become increasingly commonplace. In 2009, new auto loans with a term of six years or more accounted for 26 percent of all loans originated. By 2017, it was up to 42 percent.14
"Consumers with a six-year long loan are twice as likely to default as those with a five-year loan.15 Borrowers with these longer-term loans are also more likely to have a poorer credit history. An analysis by the
"This period also saw the rise of more outright abusive and predatory tactics in one part of the auto credit market: dealer financing.
INDIRECT LENDING
"A direct loan, or a loan a consumer gets directly from a traditional financial institution like a bank or credit union, is the safest avenue for consumers. There are clear laws, regulations and oversight over this kind of transaction.
"Indirect lending is when a consumer finances through a dealership, with the exception of Buy-Here Pay-Here lots which provide in-house financing. In dealer-arranged financing, the dealer is a creditor in this arrangement, selling the loan to another financial institution, and often having the consumer sign a retail installment sales contract. Dealer-arranged financing creates incentives that often work to the detriment of consumers, and it is governed by rules that are often less protective of consumers' interests.
ABUSE
"One major area of abuse is excessive interest rates. Dealers have the ability to mark up the interest rates they receive from the lenders to whom they sell their finance contracts, pocketing the difference as profit.17
"Having consumers sign a retail installment sales contract not only allows a dealer to charge a higher interest rate, these rates can sometimes exceed state usury limits. In one example, a package of securities
"There's also been evidence of lenders failing to verify the income of borrowers. For example, in 2017,
"Dealer-arranged financing has also enabled discriminatory pricing. Since its creation, the
"In 2018, however,
"These are only a few examples of the ways dealer financing threatens the financial well-being of Americans. There are add-on products dealers can make to sound mandatory, and yo-yo financing practices that force consumers to renegotiate after they were told the deal was done.22 The entire list of threats consumers - and particularly the most vulnerable amongst us - face is appalling. That so little action has been taken to stop these predatory behaviors is even more so.
CONCLUSION
"Americans currently owe more for our cars than we have at any point in history. More of us are making monthly car payments and we're paying them off for longer. Delinquencies are rising even though the economy is strong, and it's in large part due to lending practices designed to get more people into a new car as soon as possible, including abusive and deceptive tactics that target borrowers with the most to lose. I think we can all agree that American consumers deserve better."
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Footnotes:
1
2 Based on
3
4 Ibid.
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6 Percentage of GDP calculated based on outstanding auto loan balances from
7 Ben McLannahan, "Debt Pile-up in
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15 Ibid.
16 Ibid.
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