Are car loans a slow-motion car crash?

Are car loans a slow-motion car crash?

Subprime: reckless drivers

The first step in understanding trends in auto credit is to look at the pool of US auto loans broken out by the borrower’s creditworthiness: prime versus subprime.

Of course, the term “subprime” triggers alarming flashbacks to the global financial crisis. Subprime mortgages played a big role in the financial meltdown that ran from 2007-2009. However, we believe that the deterioration in subprime auto loans has less severe implications.

Delinquency rates in subprime loans have indeed seen a significant deterioration. On the other hand, the data for higher quality borrowers looks much more like that in other areas of consumer credit i.e. delinquency rates are normalising, but remain at low levels.

Loans passing more than 90 days overdue, by credit score at origination
(Four quarter moving average)

car_loan_delinquency

Despite headline-grabbing comparisons with mortgage-backed securities, subprime auto lending is quite a small pool. Subprime auto loans, at $270 billion, represent only a minority (25%) of total auto lending and a tiny proportion (2%) of the $12.6 trillion total in US consumer credit.

Furthermore, investors should remember that not all lenders are taking the same levels of risk. Subprime auto lending has grown since the crisis, but the data suggests this has not been driven by systemically important banks or automotive captive finance companies or “fincos”2.

The culprits behind the rise in subprime auto loans are primarily new entrants to the market: mostly private equity-backed non-bank financials (NBFs). NBFs have accounted for the vast majority of sub-prime auto lending in recent years, and are even more dominant in the “deep-subprime” space: lending to those with extremely low credit scores, or none at all.

Meanwhile, established lenders have actually been pulling back from this part of the market, with new lending by market leaders Santander Consumer and Ally Financial down 25% in Q4 2016. Federal Reserve surveys show tightening bank lending standards in auto loans since early 2016. Automotive fincos have very modest exposure to subprime.

Some NBFs will likely come unstuck when we experience an economic downturn (or sooner), but mainstream lenders should be relatively well insulated.

2018 Interest Rate Forecast: How the Fed Rate Hike Will Impact You

2018 Interest Rate Forecast: How the Fed Rate Hike Will Impact You

Image result for loan

How the Fed Funds Rate Impacts You

Because the Fed funds rate ultimately influences many other market interest rates, a variety of interest rates exist, from the higher car note rate to the rock bottom return on your bank savings account.

Additionally, the Fed funds rate influences the prime rate, the interest rate awarded to bank customers with the best credit, which is tied to various loans and savings account yields. Today, the prime rate is 4.25 percent — the highest level of the year and 3 percent above the fed funds rate. You can estimate the prime rate by adding 3 percent to the fed funds rate.

Since January 2017, the Fed has raised rates three times, bringing the important interest rate to a range of 1.25 and 1.50 percent. The low 4.1-percent unemployment level and continuous growth of wages support this federal funds rate projection. But don’t expect rates to stop there: In her recent speech, current Federal Reserve Board chair Janet Yellen stated the Fed’s goal of reaching a 2-percent inflation target.

Looking forward, next year’s interest-rate forecast includes three quarter-point increases and two increases in both 2019 and 2020. Find out how these interest-rate boosts might affect your finances in 2018.

Gloomy Savings Rates Forecasts

Retirees and savers are tired of the low-interest rates and are looking forward to the Fed raising interest rates. Despite the modest rate increases this year, the average money market savings account rate remains a paltry 0.11 percent, according to the FDIC.

Fortunately, an interest rate hike should slightly increase savings account rates, according to a recent MarketWatch article. But don’t expect to make a fortune using a savings account as your only growth tool.

For the best rates, you might consider seeking out promotions at online banks, which have lower overhead and can offer higher rates than traditional banks. For example, if you invest $5,000 in a one-year CD at online Ally Bank, you can expect to receive 2.10% APY, which is far superior to the current national CD rate of 0.36 percent. If you deposit more money, you can earn an even higher rate.

How Do I Get a Car Loan?

How Do I Get a Car Loan?

Related image

Getting a car loan seems relatively straightforward. You figure out how much you can afford to pay each month and how many years you want to be paying it. You shop around for the best loan deal you can find and get pre-approved. Then you pick out your car, finalize the loan, and drive away. Easy, right? Well, yes—if your only goal is to get any old car loan. But if you want to get a good car loan, there are a few more steps you should take that will save you money and keep you in control of the process.

  1. Start by reviewing your credit report and score. This will help you get a rough idea of what interest rate you’ll be charged for a loan. See if there are any negative or derogatory entries on your credit report that can be eliminated quickly to boost your credit score. Better credit = better APR.
  2. Take a close look at your finances. Your income and monthly expenses, rather than your desire for a cool new car, should drive your decision about how large a loan to seek. Some experts recommend that you spend no more than 10% of your after-tax monthly income on a car payment, but this rule of thumb is subject to a number of other factors. Do you live in an expensive city? What do your monthly bills look like? Are you buying a car that will be especially expensive to insure or maintain? Be conservative in estimating how much you can pay each month—and don’t forget to factor in insurance, maintenance, and fuel.
  3. Calculate how much of a loan you can safely afford, given your credit history, your income, and your expenses. There are a number of car loan calculators that make this process easy.
  4. Figure out how to make the largest down payment you can. Putting more money down will lessen the likelihood that you will be underwater on your car loan. A larger down payment may also reduce the interest rate you pay on your car loan and save you a great deal of money.

Armed with this information, your next step is to shop for a loan. And “shop” is the right word here. An auto loan is a major purchase, one that you’ll likely pay thousands of dollars for. Treat it as such, not as simply a means to getting car of your dreams. Check with both the banks and credit unions you do business with, and also with those you don’t. Consider online car loans, especially if your credit is less than stellar. Also, make sure to ask yourself the following: Are there prepayment penalties? Are there origination fees? Can payments be made online? And—this is important—do all your loan shopping in less than two weeks. Why? Because credit bureaus knock points off your credit score every time someone does a “hard pull” of your credit history. But they treat a cluster of similar inquiries made within a two-week period as a single inquiry. In other words, they don’t penalize you for shopping around, so long as you do it quickly.

Be aware that many dealers may try to sell you a more expensive vehicle than is prudent for your budget. And they may also offer their own in-house financing deals to make it easier for you to buy a pricier vehicle. Typically, though, these deals that look wonderful in the salesman’s office come with longer payoff terms. And that means paying more interest. Not all dealer-assisted financing is a bad deal, of course. Sometimes dealers will have access to financing options that individuals do not. But be wary. A loan is only a better deal if it costs less over its lifetime.