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Repossession Recession?

About one third of the 330 million Americans have auto loans. Here’s some information about those loans:

  • In 2017, the average amount we borrowed for a new car was $31,099, an average monthly payment of $515 (source)

  • We’re borrowing an average of $21,375 for a used car, which works out to $398 a month (source)

  • At the end of 2018, 7 million Americans were in “serious delinquency” (90 days past due), according to the Federal Reserve Bank of New York – an all-time high

  • The average interest rate on auto loans varies depending on the source, but seems to be somewhere between 7% and 11%

  • Those with poor credit end up with an interest rate of 16% or more (source)

Why does this matter to the economy? According to an article in Fortune’s May 2019 edition, Auto Loans: America’s Other Subprime Problem, 22% of auto loans (50% of those underwritten by auto-finance companies) qualify as sub-prime, meaning people with very low credit scores took out the loans. For those keeping an eye on this situation, myself included, we’re getting a sinking feeling of déjà vu because Wall Street continues to show its penchant for asset-backed securities. And those assets can be sub-prime auto loans.

You may be curious about what an asset-backed security is and why they’re important. According to Investopedia, issuers pool a bunch of assets, like mortgages or auto loans, together (this is called securitization) into what are then called asset-backed securities. The issuers sell these securities to generate more cash, which can then be used to generate more loans. Investors who purchase the securities from the issuer receive cash flows from the underlying loans, so in that way they’re similar to investing in bonds.

The idea is that the loans packaged together will not all default at the same time, so they would have different maturity dates, interest rates, and even different geographic locations. The securities have three or so tranches. With tranche A having investment-grade loans (high credit borrowers), then tranches B and C would contain lower quality loans. Leading up to the mortgage crisis and the Great Recession, issuers were packaging sub-prime housing loans into these securities, then taking the lowest tranches and packaging them together. The thought was that housing prices rarely decrease and if they did, it wouldn’t be throughout the whole country at the same time. When homeowners started defaulting across America, the securities which were backed by those mortgages became worthless, hurting issuers and investors.

In short, mortgage-backed securities led to the Great Recession. Now that we’ve recovered from that, it appears the new sub-prime loans to be keeping an eye on are car loans, since asset-backed securities are being sold with them in their tranches. The bright side here is that the total amount of loans outstanding right now is about $1.3 trillion and that’s how much debt Americans had in mortgages alone heading into the 2007-2008 downturn.

We all need to learn that just because you can be approved for a loan, does not mean you should take out that loan.

You may be one of those Americans with an auto loan. I have been there too. Do you know what your interest rate is? If it’s in the double digits, consider shopping rates around and refinancing your car to a lower rate. For example, let’s say you bought a $20,000 car and put $4,000 down including your trade and your interest rate is 12% and the loan term is 60 months (5 years). You’d pay over $5,000 just in interest. That’s more than your down payment! If you were able to get a 6% interest rate instead, you’d only pay half that, about $2,500. Another option is to hustle to pay the car off sooner by making principal-only payments.

This next part is very important. Once you pay your car off, do not fall into the trap of getting accustomed to a car payment. Do not immediately get another car with a payment. Take the money you were paying on your car and put it into savings instead.

If more Americans would take these steps, we could avoid the upcoming auto loan crisis.

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