Is Subprime Lending Fueling the Auto Surge?

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New research shows that lenders are loosening their standards for auto loans for people with damaged credit, but this is better news for lenders than it is for borrowers — or auto companies. 

In a quarterly study, credit scoring company FICO found that just over half of lenders say the biggest increase in subprime lending will be for car loans, a jump that comes as the new-car market regains its bearings and picks up steam again. Last month, new cars were selling at an annualized rate of 14 million, up 22% from last year. For the auto industry, Automobile Magazine declared the month of June, “certainly its best since the halcyon days of 2007.” Lower gas prices probably contributed to this surge, but so did lots of rebates and incentives, frequently in the form of ultra-low or interest-free financing offers.

This sounds like a good combination: more demand for new cars and more money available to finance them. But if you’re the auto industry, subprime credit isn’t necessarily the kind you want fueling your rebound. Sure, it’ll do the job for a while, but the more money customers have to spend on financing, the less car they can buy.

And if you’re a customer, subprime credit definitely isn’t the kind you want financing your new wheels. Dealers use lots of tricks, like extra-long loans that stick car owners with negative amortization — that is, “underwater” vehicles — or high monthly payments that ultimately prove unsustainable.

(MORE: 4 Rules for Getting a Car Loan)

The vast majority of lenders in the FICO survey say they anticipate credit availability for car loans to meet or exceed demand over the next six months, even though more lenders this quarter think auto loan delinquencies will go up.

So, are these lenders cranking out loans they know are going to fail? Not exactly; lenders have all sorts of strategies in place to mitigate borrower risk, most of which involve charging you more. Rosemary Shahan, president of Consumers for Auto Reliability and Safety, says only about one in 10 shoppers will ever see that coveted 0% financing rate, and it’s likely that number is only going to climb in the coming months.

(MORE: Car Shoppers’ Decisions Most Influenced by … Person Trying to Sell Them Cars?)

That’s because our collective credit status appears to be slipping. New data out from the Federal Reserve shows that we piled on more credit card debt in the month of May than in any one month since the pre-recession days of late 2007. Overall, we took on $17.1 billion in new debt in May, including credit card as well as other non-mortgage debt.

An economist interviewed by the Associated Press says this isn’t because we’re more confident about the economy; it’s because we’re struggling. ‘‘It is possible that households are relying more and more on credit cards to cover everyday expenses, given that job and income growth are so weak,’’ he says. This is the kind of debt that can have long-term, expensive ramifications.

A little refresher: Roughly a third of your credit score is based on your credit utilization ratio — how much you’ve charged as a percentage of your credit limit. Under 10% is best and over 30% can be a red flag. More credit card debt means more of us are going to slip below that subprime threshold, limiting our availability to get car loans at a decent rate even if both loans and cars are plentiful.

So if you’re expecting to walk into a dealership and score interest-free financing, do your homework and brush up on your credit knowledge first, or you could wind up disappointed — or paying a lot more than you planned.

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