4 Reasons Subprime Loans Are Back (For Cars)
"I wasn't even looking for a new car," Katrece Poole told me. But two years ago, a local car dealership running a direct-mail ad campaign sent her a letter saying they were making loans to lots of buyers. So she went down to the dealership, filled out the paperwork, and got approved — despite the fact that her car had been repossessed in 2005 because she missed payments.
Subprime car loans are a big deal these days. More than a third of auto loans are now going to subprime buyers, according to one estimate. Here are four reasons:
1. Lenders can charge high interest rates on subprime loans (as high as 25 percent in some cases).
2. Default rates are low. People often need their cars to get to work, so they prioritize making their car payments.
3. Used car prices are at near historic highs. So when people do default, lenders can often get all of their money back (and, in some cases, more) by repossessing the car and selling it at auction.
4. Lenders can package their loans and sell them to Wall Street, where they are broken into pieces and sold off to investors.
Breaking loans into pieces and selling them off to investors may sound familiar to anyone who watched the housing boom and bust. But auto loans are unlikely to bring down the global economy — they're a tenth the size of the mortgage market, and even during the recession they performed pretty well.
There are worries about subprime borrowers getting trapped in loans they can't afford to pay back. But as more lenders compete for borrowers' business, rates may fall. In fact, Katrece Poole's credit union recently helped refinance her original subprime loan, cutting her interest rate in half.
ROBERT SIEGEL, HOST:
The subprime loan is back, but not for buying a house. Financial institutions are increasingly willing to lend large amounts of money to people with poor credit so long as they're buying a car. Here's Lisa Chow of NPR's Planet Money team.
LISA CHOW, BYLINE: Katrece Poole is 32. She's a single mom. She makes just over $14 an hour working in food services at a university in Rochester, New York. In 2005, her car was repossessed because she started missing payments. In 2011, when she went to buy a brand-new Mitsubishi...
KATRECE POOLE: Went, filled the paperwork out, and I got approved.
CHOW: Were you surprised that you got approved?
POOLE: Yeah. I was like, wow, OK.
CHOW: In fact, Poole had been targeted by the dealership. They had sent her direct mail saying they had loans for people like her.
POOLE: I wasn't even looking for a new car. I was going to keep that car. But I started having problems with the truck in 2011, then I've seen - Marina Dodge sent me a letter saying that I can get a brand-new car. So I went out there and took the letter, and it's like, yeah, we can help you.
ANTHONY PANARELLA: We find that direct mail works well for us here in Ozone Park, Queens.
CHOW: Anthony Panarella has sent a lot of letters like the one Poole received. He manages a Nissan dealership in a different part of New York. He targets borrowers with a decent income, at least $30,000 a year, but poor credit.
PANARELLA: We just had a customer that came in the other day that had a 510 score with two repossessions, and we put him in a brand-new Nissan Versa. The guy was happy as hell.
CHOW: So why is Panarella so eager to attract borrowers like this? There are a couple of reasons. He can get a high interest rate on these loans, up to 25 percent. Default rates on car loans are pretty low. People need their cars to get to work, so they'll do everything they can to make the payments.
And even when people do default, Panarella can take the car and auction it off. And it turns out, because there's a lot of demand for used cars right now and little supply, prices are good. Panarella says he repossessed a car about a year and a half ago.
PANARELLA: The car made positive $3,000 at the auction on top of what this man paid for, on top of what the car cost us. So...
CHOW: You actually made money off of the repo.
PANARELLA: Yes, absolutely.
CHOW: A final factor driving up subprime loans in autos, Panarella doesn't have to hold the loans themselves. He can originate them, package them and sell them onto Wall Street. Panarella says when he put the word out to Wall Street that he had a portfolio full of subprime auto loans to sell, with an average interest rate of 17.5 percent and few defaults...
PANARELLA: The phone was ringing off the hook. We sold two portfolios already to Wall Street. And, yeah, I mean, I'm seeing more and more Wall Street activity coming into auto lending.
CHOW: To the officials at the Federal Reserve trying to fix the economy, this is what they're hoping for. By driving interest rates so low, they're hoping to encourage financial institutions to lend more freely. Karl Brauer is the senior director at Kelley Blue Book. He says that's one reason you're seeing all this activity in auto lending.
KARL BRAUER: There's a lot of new and nontraditional financial institutions out there that are coming in that can come up with ways to lend money or to package these loans all together in their kind of an investment portfolio, and so people are doing that. Now, that might sound familiar because this is what they were doing with home loans up until about six years ago.
CHOW: But Brauer says he's not too worried about bad car loans bringing down the global economy. They're a tenth of the size of the mortgage market in the U.S. And during the recession, they performed relatively well. But what about the people who take out these high-interest loans? I put the question to Poole, our car buyer. The subprime auto loan, is it a good thing or bad thing?
POOLE: I think that's a good thing. I think everybody need a chance to start over and build their credit up even if you have a repossession or anything.
CHOW: Even if it's a high-interest loan?
POOLE: Yeah, because how else you going to get a car?
CHOW: Credit experts would say there should be cheaper ways. And, in fact, Poole's credit union helped refinance her original subprime loan, cutting her interest rate in half. It's possible that as more firms fight to lend money to people like Poole, interest rates will fall and Anthony Panarella, the car dealer, says that's already starting to happen. Lisa Chow, NPR News. Transcript provided by NPR, Copyright NPR.