Given the recent history of the American economy and, more specifically, its lending institutions, there remains some understandable trepidation from consumers.
Too many people were victimized by the housing market crash of 2008 because of irresponsible practices that included a rash of subprime mortgage loans, and that sector is only now climbing back to its feet. Among the repercussions were thousands of homeowners who ended up in foreclosure, and ultimately, a large wave of new regulations and risk assessment standards to which lenders must adhere regardless of their contributions to the fallout. As that industry continues to pick up the pieces, another sector of the lending world faces a potentially similar bubble that many experts are concerned will result in another burst.
Steady, but perhaps not healthy, growth
The automotive financing industry represents a $55 billion-per-year spending contingent, according to Experian data as reported by Forbes. Subprime loans make up nearly half of that total for a marketplace that's been steadily profitable, with net margins ranging between 30 and 40 percent. But questions have arisen regarding not only the nature of many recent auto loans, but also the safety with which they're being issued.
According to an August report by the Federal Reserve Bank of New York, auto loans provided to borrowers with lower credit scores have been on the rise. And although the frequency with which such loans are being given is not at the level of the pre-recession housing finance sector, there are growing concerns about the trend being established. During the second quarter of 2013, nearly 25 percent of new auto loans were issued to consumers with credit scores below 600, per a New York Times report of the Federal Reserve statistics. The portion of new auto loans going to people with the best credit scores - those at 720 or higher - is down to approximately 45 percent.
Where's the next wave?
Lending as an industry, including mortgages and car loans, has not risen back to the point of pre-recession levels. People are generally applying for and being approved for loans with less frequency, something that's generally attributed to the fears of a younger generation of would-be buyers as well as a lack of consumer confidence derived from a variety of factors such as reduced income, unstable employment and massive amounts of student debt. Still trying to climb from the rubble of their education loans has many young people restructuring their priorities, and in turn 18-to-29 year-olds have not accounted for one million loans during a quarter since early 2008- a benchmark that demographic reached every quarter from 2000 to 2007.
So, while the higher rate of loans being provided and the relaxed standards for borrowers have not necessarily carried over to that next generation, there is speculation that younger consumers will soon return to the mix even if it's not fiscally advisable. As lending standards for auto loans are increasingly relaxed, the underlying, looming fear is that a fate similar to that met by the housing market in 2008 is on its way.
Auto lending advocates argue that the industry remains stable, that practices and standards have not been relaxed and that the automotive financing processes are inherently different from those of the mortgage world, where securitized loans are the norm. Interest rates remain favorable for prospective car buyers, but auto lenders insist not just anyone is being cleared for approval.
The next few years will be pivotal in terms of determining the ultimate direction and fate of the auto loan industry. Whether a new generation joins the market - and how much lenders concede in allowing for that new infusion - will play a major role in the difference between a burst bubble and buoyancy.