2

This might be a better fit on the economics SE, but having browsed both I feel the body of knowledge here is more applicable.

For as long as I've heard car ads on the radio or TV I feel like I've heard "Get this car for $0 down. Bad credit? No credit? No problem! Drive away today!" and so on. Now I'm sure these people have to pay higher interest on their car loan than others, but I can't shake the feeling this is similar to the housing bubble in which the most qualified people already had houses but the real estate industry still needed to move houses, so they started making bad loans which resulted in a spree of defaults.

A car is not a house of course (well, usually at least) but it still seems off to me. How, if at all, are car dealers benefiting from this?

  • 2
    High interest rates, high prices and aggressive repo men. – RonJohn Dec 29 '17 at 18:14
  • 1
    Also small quibble - 'No credit? No problem!' does not necessarily mean that every person who applies for a car loan is approved. For example, the dealership may still require a recent paystub to show that you at least have a job. So the list of people expected to stop making a payment might be smaller than you assumed, as some vetting has still occurred. – Grade 'Eh' Bacon Dec 29 '17 at 18:49
9

There are a few reason this is different than the sub-prime mortgage crisis, and why doing this can be profitable:

  • Interest rates for these vehicles is commonly far, far higher than 'regular' car loans (think 10%+ vs 3%). That much of a rate differential wasn't really seen in mortgages in 2007, even 'NINJA' loans.

  • The cost of the car itself can be easily inflated; selling a $3k car for $6k skyrockets your profit, but in the home mortgage crisis, the banks didn't set the prices of the homes they were selling.

  • A car can be repossessed far quicker than a home can be sold. Once repossessed, the car can once again be sold. The dealership makes money as long as the payments made before repossession are > the administrative costs so far + the car's short depreciation over a few months [old used cars don't actually depreciate very quickly, as most depreciation occurs within the first year or two of a car's life].

  • If you lose your job and need to move to get a new one (ie: one of the cascading impacts that worsened the global financial crisis after the sub-prime lending collapse), you can take your car with you, but can't take your house. So, even in dire straits, you may be able to continue making car payments even when you would default on your mortgage.

  • One critical element that made the GFC as bad as it was, was mortgages with 'balloon payments'. ie: paying only interest on your mortgage for 5 years, and then being forced to pay the entire outstanding principal balance all at once. This was done in the theory that, as long as the house maintains its value (or increases), you could easily get refinancing just before the balloon payment, causing you to eternally defer the actual payment of the principal balance. Of course, if many people in your city lose their jobs, and home prices go down, your home isn't worth as much, and you might need to make that balloon payment when you yourself are between jobs. This is not the same problem with used cars, where even if interest-only payments exist, the balance is closer to 10k than 100k.

*I am ignoring complications with fees for separate lending entities or towing / repossession companies; they also make their money through the general process noted above, so for this discussion you can ignore the distinction and the fees that float between these companies.

2

If you have bad credit and just need a car, they can charge a higher rate, higher price, and if things go south, they can take the car back and re-sell it again. As long as the money received out-paces depreciation and cost of repossession/resale, they come out ahead even on defaults.

So they play the odds, many people with bad credit will keep up on car and rent payments, because they are essential to their lifestyle. Unsecured debt (credit cards) are the primary cause of poor credit scores, while car default rates are relatively low, so not a huge risk.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.