The good news first. The Federal Reserve has started lowering interest rates again. The bad news? Borrowers aren’t seeing the benefits of those lower rates in time to help them make timely auto loan payments. And banks are facing loan defaults in frighteningly large numbers. What kind of numbers? Auto repossessions have jumped 23% from last year.
“Lenders must now deal with the issues inherent in the body of auto loans already made, including rising delinquencies, and the continuing hangover of pandemic economic trends, compounded by inflation and higher interest rates before the Fed’s cut. Unlike many credit cards and mortgages, car loans typically carry fixed rates, so consumers who already have auto loans won’t feel the rate cut directly.”1
The Financial Brand’s recent article, Amid Rising Delinquency Rates, Auto Lenders Seek Safe Growth, points out the difficulty borrowers are now having with their auto loan repayment, and the difficulty banks now face with auto loan delinquencies. The delinquency rate was 1.4% in Q2 2024, up from 1.3% a year earlier and double the level for Q2 2021. In August, according to the article, “TransUnion said the 60+ delinquency rate (60+ days) on autos had hit 1.6%, its highest level since the 2008 financial crisis.”
How’d this happen? For many lenders, the pandemic days of loan repayment forbearance and federal stimulus payments – beginning in the second quarter of 2021 – created an environment that encouraged many to start aggressive auto lending. “The share of consumers with subprime credit scores — those with higher risk profiles and lower credit scores (typically below 620) – has been falling since the end of the Global Financial Crisis. Goodman et. al (2021) documented that this decline accelerated starting in 2020, largely driven by COVID-19 relief policies such as the Coronavirus Aid, Relief and Economic Security Act's forbearance provisions. Over the course of the pandemic, the share of borrowers with subprime scores fell from about 23 to 18 percent, the lowest level since the late 1990s.”2 This led banks to make more car loans to these “reclassified” subprime borrowers in what has come to be known as “credit score inflation,” or “credit score migration.” For banks, the benefits were obvious enough; more borrowers at higher interest rates.
It wasn’t the days of repayment forbearance and stimulus payments alone that has led to where lenders, and borrowers, are today. Other factors contributed to the credit inflation trend, as well, including larger loan amounts (from January 2020 to January 2023, average required monthly payments increased from $470 to about $600)3, the removal of medical debts and civil judgments from credit reports, and more lenient rules regarding late payments and defaults. While these changes were intended to help consumers, they have had the unintended consequence of giving lenders a skewed sense of a borrower’s true financial stability. To make matters worse, subprime borrowers are more likely to experience financial disruptions, such as job loss or unexpected expenses, which can make it even harder for them to meet their auto loan obligations. An inflationary cost of living, along with the expiration of forbearance programs, has left many of these households with less income to cover loan payments.
Repossessions are on the rise
While fiscal stimulus flowed to help prop up American households and the broader economy, consumers were able to stay current on their bills. And many lenders were more amenable to working with customers who fell behind. Times have changed, however. “Through the first half of this year, defaults have grown and car repossessions are up 23% from the first six months of 2023, according to Cox Automotive data released earlier this month. Delinquencies are climbing at rates not seen since the Great Recession.”4
Now would be a good time to promote your auto refinancing. In The Financial Brand article, Charlie Wise, SVP Research and Consulting at TransUnion, suggests that “one potential benefit of the cut for lenders seeking volume and market share going forward is the opportunity to refinance existing car loans as rates continue to fall, if the central bank sticks to its plans.” That seems to me like a pretty good idea.
What to do?
Credit score inflation and the expansion of subprime auto loans have created a dangerous situation for both lenders and borrowers. While subprime loans can be profitable, they also come with significant risks. Rising delinquencies are a clear sign that many borrowers are struggling to keep up with their payments, putting both their financial futures and the health of the lending market at risk. To mitigate these risks, lenders must do their best to maintain realistic lending standards, and closely monitor the creditworthiness of their borrowers.
As of mid-2024, Americans are carrying over $1.6 trillion in auto loan debt, an increase of nearly 80% over the past decade. Auto loans now account for roughly 9% of total consumer debt, trailing only mortgages.
Now is a good time to reach out to customers who are struggling with their auto loan payments and offer them an alternative: A refinancing product that enables borrowers to keep up with their payments … and keep their vehicle.
Bank Marketing Center
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1The Financial Brand. Amid rising delinquency rates, auto lenders seek safe growth. September 27, 2024
2The Federal Reserve Bank. The Effects of Credit Score Migration on Subprime Auto Loan and Credit Card Delinquencies. January 12, 2024
3The Federal Reserve Bank. Rising Auto Loan Delinquencies and High Monthly Payments. September 26, 2024.
4CNN Business. It’s becoming harder to get – and keep – a car. July 22, 2024