Subprime Auto Loans Could Be Impacted by Proposed Tariffs
Inside Subprime: July 31, 2018
By Ben Moore
The Trump administration has recently proposed a 25 percent tariff on all imported cars and car parts. In response, the automotive industry is expressing major concern over the potential the tariffs have to seriously restrict the car buying power of low-income shoppers. These shoppers have historically used subprime automotive loans to purchase new cars, with imported cars such as the Nissan Sentra, Kia Forte, and Hyundai Elantra being the top sellers of the past fiscal year. The tariffs run the risk of increased interest rates, jeopardizing the borrower’s financial health and pushing them into an even larger amount of debt. It is also estimated that the price of those cars will increase by 10% if the proposed tariffs go into effect.
Under the guise of Section 232 of the Trade Expansion Act, which gives the president power to enforce trade restrictions based upon the grounds that there is a national security risk, the Trump Administration’s tariff proposal has created an uproar in the auto industry. The industry is “furiously” working to deter Trump and his administration from moving forward, claiming that the tariffs will mostly affect low-income buyers who already have a difficulty consumer path to securing a new car. Jonathan Smoke, the chief economist at Cox, voiced his concern over the tariffs and how they directly “impact lower-income and lower-credit consumers.” He notes that they are “the consumer that’s already struggling with higher prices, higher gas prices, [and] higher interest rates” and “the [tariff] would push new vehicles out of consideration.” GM even issued a cautionary statement saying that “the vehicles that will be hardest hit…are often purchased by customers who can least afford to absorb a higher vehicle price point.”
Recently, auto lenders have had to become more strict with subprime loans, raising interest rates slightly to offset the costs of loan defaults. The rates for bonds and the advertised car loan rates have increased more significantly which has been an indication that automotive companies are subsidizing the subprime loans so that the loan payments are still somewhat affordable. Unfortunately, subprime loans have become so popular amount bad credit borrowers that there is now speculation around the possibility that the loans have created a bubble that teeters on the verge of bursting. The astronomical interest rates of these loans, with some reaching as high as 29 percent, has created an easy and appealing way for investors to profit, since the loans are packaged into bonds and subsequently sold to these investors, who are typically mutual funds and insurance companies. This quick flow of profit is what has sparked the speculation of an automotive bubble, as these high interest loans continue to run the risk of default, with about one in three subprime loans reaching default status. Auto loan borrowers have become more willing to take on increased debt in order to purchase a new car, and with overall car sales seeming to have plateaued, the Federal Reserve has subsequently raised the cost of borrowing, which has increased default rates and the speed of car depreciation, adding more and more concern to an impending auto bubble burst.
With the fear of an impending auto bubble on the verge of bursting and the addition of a potential increase in car prices due to Trump’s proposed tariff, the ones who are most at risk, the low-income car buyers, show no signs of halting poor financial decisions when going about purchasing a new car. In fact, over the past few years, the percentage of auto loans that are labeled subprime has increased from 5.1 percent to over 30 percent. With typical subprime loan terms lasting anywhere from between 73 to 96 months, borrowers will potentially pay more than double the cost of the car by the end of the term. That cost will grow even further with these tariffs, trapping these shoppers in a deeper amount of insurmountable debt.