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Subprime car loans return to favor with lenders

August 3, 2012
Consumers without top-tier credit are finding it easier to get new car loans, as banks and other lenders are lowering the scores needed to qualify.
While that means additional sales for automakers, and enables more motorists to get into new cars and trucks, it raises questions as to whether lenders are falling into the same risky lending practices they followed before the recession.
“There are a lot of lenders now that are into the subprime business,” said one dealership sales manager. “What used to be a good score at a 650 or 700, now 550 is a good score.”
During the first quarter of this year, total U.S. car loans totaled $52.5 billion. That’s 49 percent higher than the same period in 2009 — the recession’s low point — according to Equifax’s National Consumer Credit Trends Report. Also during the first quarter, the average amount financed on new vehicles rose by $589, to $25,995, and for used cars by $411, to $17,050.
Furthermore, buyers are stretching out payments for longer terms: The average length of new- and used-vehicle loans jumped a full month during the first three months of this year, to 64 and 59 months, respectively.
More loans and looser lending restrictions have helped boost new-car and -truck sales to levels not seen in four years. Estimates call for 14 million to 15 million vehicles to be sold in the U.S. this year, about 30 percent higher than in 2009.
“We’ve certainly seen the market loosen up for subprime,” said Melinda Zabritski, director of Automotive Credit at Experian, a consumer and business credit reporting firm.
“We’re seeing it very close to what it was in pre-recession levels, but those days we probably will not return to. I think you’ll still see the loans themselves a little more conservative.”
Bank risk professionals expect a lending increase to borrowers with less desirable credit. The analytics company FICO polled 192 risk managers at banks throughout the United States last month and found that half predict growth in subprime auto loans will lead all other sectors for 2012.
It’s easier for banks to loan money when interest rates are low and the rate at which banks loan money to one another is close to zero percent. That’s one reason subprime auto lending is already on the rise.
Room for subprime to grow
Subprime consumers generally have credit scores of 640 and below, though cutoffs vary by lender. Scores range from 300 to 850; people with scores above 720 are generally given favorable interest rates, because they are seen as more likely to pay their bills.
The average credit score for people financing a new vehicle remained substantially higher than subprime during the first quarter, but it dropped six points, to 760; for used vehicles, the average credit score dropped four points, to 659, analysis by Experian found.
Experian, one of the major credit reporting firms, expects the average credit score for new-car buyers could fall as low as 750. That estimate is comparable to credit scores during the first quarter of 2008 — just before the collapse of the economy and auto industry — when credit scores averaged 753 for new-car buyers and 653 for used-car buyers.
The subprime category typically comprises about one-quarter of the new-vehicle finance market, Zabritski said. That explains why the average credit score for new-car loans is still higher than the subprime average. But there’s still room for the subprime category to grow.
The number of vehicle loans made to people with less-than-desirable credit jumped 11.4 percent this year. Lenders not only are loosening their leashes, but more subprime customers are also seeking out auto loans.
Those subprime customers, however, aren't getting the rates they could, said Hank Hubbard, president of the nonprofit Communicating Arts Credit Union in Detroit, which helps those with poor credit refinance loans at better rates. Many, he said, are paying 25 percent a year.
"You could argue from a social perspective that disadvantaged people paying 20 percent interest rates is not such a good thing," said CEO Jeremy Anwyl, "but from a credit perspective, it's not a bad practice."
Consumers 'have a choice'
Hubbard said for the past few years, many of the credit union's customers who have credit scores below 640 had the impression they would not be approved for an auto loan — or would be approved, but only with a sky-high interest rate.
"People don't realize they have a choice," Hubbard said. "(The lenders) are taking people with decent credit and charging them high amounts." He points to a story of one man who was saddled with a six-year used-car loan with a 24.95 percent annual percentage rate. He had a monthly payment of $619 and was on track to pay as much in interest as he would for his 2005 GMC Yukon. CACU refinanced him twice and lowered the monthly payments to $386.