The Subprime Lending Bubble Is Totally Bursting, Maybe

August 19, 2015

Remember the Great Recession? It upended the world less than a decade ago, but already, some folks seem to have forgotten its lessons. And according to the financial blog Zero Hedge, we may be doomed to repeat them.

If you're not familiar with Zero Hedge, it's well worth a look. It's written anonymously, with many of the site's editors posting under the pseudonym "Tyler Durden". (That's the name of Brad Pitt's character from Fight Club, who turns out to be...well, we won't spoil it for you if you haven't read the book or seen the movie.) Their true identities remain a subject of much debate, but given their analytical skills and financial knowledge, it's pretty clear that some, if not all, work in the money biz.

One of the site's recent posts focuses on lending in the auto industry, and the conclusions that the writer draws are a little ominous. We're not financial whizzes ourselves, but the gist is that competition among banks is heating up, those banks are getting greedy, and as a result, loans and leases are being given to increasingly large numbers of consumers who may be at risk of defaulting.

In other words, we could be in a subprime lending bubble that's getting ready to burst.  

We've seen other warning signs in recent years, like record-high loans and dealers taking shotguns as downpayments. But every time questions have been raised, we've been told not to worry, that things are different this go-round.

And maybe they are, but it's hard not to be concerned about the massive sums of dough that are moving through lenders' hands and the equally massive loans to which consumers are committing themselves. Zero Hedge cites a particularly alarming selection of record highs, courtesy of Experian:

  • Average loan term for new cars is now 67 months — a record.
  • Average loan term for used cars is now 62 months — a record.
  • Loans with terms from 74 to 84 months made up 30% of all new vehicle financing — a record.
  • Loans with terms from 74 to 84 months made up 16% of all used vehicle financing — a record.
  • The average amount financed for a new vehicle was $28,711 — a record.
  • The average payment for new vehicles was $488 — a record.
  • The percentage of all new vehicles financed accounted for by leases was 31.46% — a record.

Of course, some of that's to be expected. For example, given rising auto prices, it's no wonder that the average amount financed and average monthly payments would increase over time. Frankly, it would be strange if they didn't.

On the other hand, the growing length of loan terms is probably cause for concern. Longer loans make vehicles more affordable, yes, but they also keep consumers in debt for longer periods of time. And according to decades of financial wisdom, the longer people are in debt, the more likely they are to default.

Even more troubling is Zero Hedge's point that many of these loans are going to subprime borrowers -- that is, people with credit scores below 620. Historically speaking, those borrowers pose a higher risk of default, putting lenders themselves at risk.

What's worse, many of the companies making those subprime loans aren't in a position to handle much risk. Zero Hedge cites a firm called Skopos Financial, which is in the business of facilitating loans to subprime borrowers and is headed by several alumni from subprime lender Drive Financial and at least one person from now-defunct Countrywide. Yikes.

All of us should hope that someone's looking over the shoulder of these guys and gals. (The feds may have finally made that possible.) In the meantime, if you're in the market for a new car, be honest with yourself about what you can and can't afford. And if you do need to finance, do your research ahead of time.

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