When it comes to long-term lending, the financial sector has a short-term memory.
Auto loans rose exponentially by volume in 2016, handed out by banks at nearly the same rate as student loans and becoming the nation’s second-fastest growing debt market in the process, according to the Federal Reserve Bank of New York.
Just like the mortgage-backed swaps that came before them, what seems too good to be true may be too true to be good.
To keep up demand for the contracts, lenders are once again seeking out riskier consumers to push their product on. This time, however, a new group is especially primed to land in the crosshairs: recent college graduates.
Already wracked with student loan debt, scant credit histories, and entry-level salaries, those fresh out of school can feel pressured to take whatever car—and car loan—they can get. But when both monthly payments start hitting at once, it can feel like standing at the wrong end of a double-barreled shotgun.
“As someone who recently graduated, I can tell you that balancing my car payment and student loan payment is hard as hell,” Villanova University alum Dan Doris said. “Grappling with loan payments has totally dictated my post-grad life.”
While Doris secured a job after graduating from the Pennsylvania-based university in 2015, the beginner’s pay wasn’t enough to leave his current apartment in Villanova. He needed the car to get to work, and, already cash-strapped from paying student loans, he needed the credit to get the car—a bind many new graduates find themselves in.
Moving to Philadelphia could mean vehicle-free living, but that presents its own set of financial problems, most of which involve how much more expensive the city is, he said.
“I’m stuck in this cycle of having to keep working to keep making payments, but not making enough to have the means to change my circumstances,” Doris said. “It’s been almost impossible to save up enough [to move] because I’m left with so little after making my payments. Taking out the loan for the car was the only option, but it leaves me with very little wiggle room financially.”
To pursue his professional future, Doris may have signed away his economic one. And, he’s not alone.
A Most Dangerous Shell Game
It’s been nearly a decade since the Great Recession took the world’s economy to the brink, and while overall U.S. debt is down, Americans have increasingly acquired two expensive new bills: student loans and car payments.
Combined, they’ve made up 90% of growth in consumer debt since 2012, with car loans specifically leaving buyers more than $30,000 in the red on average, according to numbers compiled by credit agency Experian.
(For their part, the class of 2016 graduated with an average of over $37,000 in student loans—more than any class that came before them—said student financial aid expert Mark Kantrowitz.)
And, more of that debt is sticking around longer. While student loans are notoriously protracted contracts, car loans are also stretching out—with an average payback period of 67 months. Nearly a third of all car loan terms now surpass 73 months. (As little as two years ago, the average loan was 60 months, itself a problematically high number, according to leading auto industry website Edmunds.)
But, as was eventually evident in 2008’s mortgage meltdown, just because loans are being issued doesn’t mean they’re being paid.
The average borrower carried $12,000 of outstanding vehicle debt in 2016, accounting for roughly 8% of disposable income, according to data from the St. Louis Federal Reserve. With student loans, that number was closer to $25,000. In many cases, the longer loan terms have meant more interest to pay down, and more outstanding debt accrued for those paying the loans.
All told, the nation racked up about $1.1 trillion in outstanding car payments as of late last year—just shy of the $1.3 trillion collectively owed for a college education, according to numbers from the Federal Reserve Bank of New York.
Perhaps most troubling, last January, delinquency rates on auto loans reached 4.7%—a record high in the post-2008 economy. Just over 3% of all car loans were more than 90 days late.
For those contending with both car and student loan payments, especially on a recent graduate’s pay grade, the reason for falling behind may be more desperate than devious.
“I figure my student loan debt should have a name soon, since it’ll be around longer than a family pet,” said University of North Carolina Wilmington grad Kate Vespucci. “And, our car loan is high, but helping our credit score.”
Credit scores can play an especially important role for recent graduates, as the group tends to have less credit history, which is a contributor to higher loan interest rates.
Like Vespucci, some may look to their car payment as a chance to prop up that score, but along with student loans and other monthly expenses, shifting payment priorities month in and month out can feel like playing a financial shell game.
“If anything, I’ve missed some student loan payments, rather than car payments,” Vespucci said. “I got them by semester, so missing one is like missing eight on my credit report. So the car payment can help offset those precious missed or not-on-time payments, but it’s definitely a difficult juggling act.”
High Risk, Low Reward?
Even as many Americans stumble along the path toward financial solvency, the lending industry itself has continued at a sprinter’s pace.
Auto Asset Backed Securities (ABS)—the car equivalent of the mortgage-backed bundles that took down the economy in 2008—were one of Wall Street’s hottest commodities last year, generating $17.69 billion in 2016’s first two months alone.
Such spectacular growth rates are infamously challenging to sustain. To help buoy the numbers, auto lenders are issuing more subprime loans; the contracts extended to those with more tenuous credit histories.
In 2015, almost a quarter of auto loans issued were subprime. While that number is actually higher than the amount of subprime mortgages issued shortly before the housing crisis—which peaked at 20% in 2006, according to statistics compiled by the University of North Carolina—some have argued that the rise of adjustable rate mortgages, which jump up in price after a set number of months, were a larger source of damage in 2008.
The thinking goes that auto loans are a comparatively safe market for such higher-risk contracts.
Still, with a larger proportion of borrows already struggling with their credit score, any impending auto loan crash would likely have the biggest impact on those already in the most financial trouble.
Even when a purchaser starts out with a relatively average amount of debt, a few instances of bad luck can make that number balloon before their eyes.
When Cory Mueller and his fiancée, Tiffany Netzel, moved to New Mexico after graduating college in 2011, they celebrated by buying a motorcycle—something Mueller said he always wanted, despite already owning a car.
At the dealership, they were told that if they bought another vehicle within a certain timeframe, they would be given the same decent APR rate on both—albeit, one that was set to jump up after 24 months. Already strapped with student loan debt, they took the dealer’s offer.
“She wanted to get her dream Jeep, and I had my motorcycle,” Mueller said. “We were both pretty stoked.”
Well before that two-year teaser rate was up, though, a tire on Mueller’s car blew out, damaging the vehicle. The couple decided to purchase another car to replace it, but, this time, the interest rate was much higher, thanks, in part, to the new debt they had just taken on.
“We went from having only $36,000 in debt, total, to $93,000. We also went from $0 in vehicle payments to $1,100 a month,” Mueller said. “It was foolish, but now they’re almost paid off and still running. We have a couple reliable vehicles that will hopefully last us a few more years.”
2017 Going on 1984?
Mueller and Netzel were lucky to conquer their mountain of debt, but, as the rising delinquency numbers suggest, many are still struggling to pull off the same feat—so many that the industry is moving to proactively protect their assets in the case of another wide-scale default.
Payment assurance devices are an increasingly common feature on cars—particularly those sold to subprime borrowers. The device, now in more than 2 million U.S. vehicles, can remotely prevent a car from starting, allowing a bank to render the vehicle useless if even one payment is missed.
Lenders are also taking advantage of the intricate web of cameras and GPS devices now installed in most infrastructure and vehicles to locate the cars they wish to repossess.
License plate readers can be found anywhere from a mall entrance to the back of a tow-truck, and banks can purchase these photos to track down a certain car. Some repo companies have even taken to the air, utilizing drones to track the vehicles they want to collect.
Once the car is gone, of course, the logistics of getting to the job needed to pay the repo company or get another vehicle become much more difficult.
While personal accountability for taking on, and subsequently paying down, debt must certainly be considered, the system is poorly designed, filled with pitfalls and booby traps. If lenders keep offering loans to those who shouldn’t have them, and those desperate enough keep taking on more debt, even more may end up falling through the cracks.