Contributing Author: Steve Klees, Senior Vice President, Specialty Channels, EFG Companies
For the past several months we’ve heard arguments across the industry about whether a subprime bubble is forming. Experian has stated in at least the last three quarterly State of Auto Finance updates that there simply is no bubble. I tend to agree. Here’s why:
For an economic bubble to form in the auto industry, the prices of vehicles must inflate well beyond the actual vehicle value, past what the market can bear. While prices for both new and used vehicles have gone up in recent years, the market is still very capable of handling those prices. The main reason for this is the combination of low interest rates and longer-term loans.
For example, take a subprime consumer who purchased a vehicle in 2009. Because of the stringent lending requirements at that time, that consumer locked in a 9% interest rate on a 60-month term loan. Then, in 2014, they decided to trade in their vehicle for a newer used-model vehicle. Because the consumer kept up with their monthly payments and possibly made other credit strides with better employment, etc., they returned to the dealership as a near-prime consumer, and were able to refinance the remaining balance into their new vehicle payment at a 3.9% interest rate. With a new 60-month term loan, their payments stay roughly the same. The consumer already proved they could afford those payments with the first vehicle, so the risk remains roughly the same.