Tax returns have been filed. Refunds have been sent to those of us fortunate to get one. Those few lucky consumers at my lot with that government issued check in hand have already bought their next ride.
It’s a quiet workplace at the lot right now. I have all of 15 vehicles, and the majority of those were either trade-ins or repos.
That’s the good news. Now time for the bad news.
A long-time car dealer met me at the auction the other day and told me this…
“Steve, one of my employees was wanting to get an ’05 Impala from me. Well, her credit wasn’t good at all and I didn’t know if I’m gonna keep her for the long haul. So wouldn’t ya know? She headed off to the Dodge dealership and got herself a three year old Charger with 22.8% interest, and all the fees in the world on a seven year note. They’re fixin’ to make 15 grand on that deal.”
The fifteen grand isn’t the real killer on that deal though. Dumb people make dumb decisions all the time. It’s not even the term of the note since seven year notes have become as common as kudzu here in the world that is sub-prime financing.
The killer is the financing company that did the deal. This company was able to steal a deal that would have been nearly untouchable a year ago. A seven year note on a late model vehicle with a customer that fielded a 560 credit score and a high debt balance.
This is the type of deal in our business that usually required you to self-finance the vehicle. Not anymore. Auto lenders are barreling deep into sub-prime territory and that’s huge for our industry.
A car that is five years newer than that ’05 Impala is now able to compete head-on with it in the used car market for the same customer and the same monthly payment.
This is good news for those of us who buy the older used car for cash and keep it until it croaks. As time goes on, the price of older used cars should come down. We may finally find ourselves with a good daily driver at a reasonable purchase price. Instead of having to pay a price premium that comes from independent car dealers trying to finance these exact same older vehicles to their customers.
According to an article on https://www.crediful.com/ – the debtors who actually buy a newer vehicle won’t have it so easy. The term for their ride will likely migrate away from the shorter three year notes, to barnacle-keeping seven year agreements.
The risk that goes along with a long-term deal for that indebted customer is far higher than what most of you would expect.
That bad credit customer will usually go to a dealership that finances their own vehicles. As a guy who does this for a living, I can tell you that making sure the car can ‘make the note’ is critically important to my bottom line.
I get parts for about 40% off what the public is charged and my mechanics typically make $15 to $20 an hour. What that means is that I can afford to perform the required maintenance on a vehicle in advance of it being due, and my cost for doing this usually comes to less than a single monthly payment.
In a three year period most car owners will experience perhaps one major maintenance experience (which I will already cover), and various times where routine maintenance will be required. The independent shop down the road from me will perform oil changes for all my customers for $20 and if there is a minor issue at hand, I can often have them catch it before it becomes a major issue.
In the last five years I have never lost a deal to a blown engine, a bad transmission, or any other mechanical issue.
As someone who finances cars for a shorter length of time, I also have far less default risk when it comes to my customers. Most folks will keep their jobs on average for 4.6 years according to the Department of Labor Statistics. So you may wind up with one, maybe two job changes on average.
A substantial number of my customers will keep the same employer over those three years. So my net risk of a default due to employment issues and overall vehicle condition isn’t that high.
Take that same customer I currently finance and keep them for a seven year period with a company that will sell that note to a Wall Street firm. Now the risk changes quite a bit.
The majority of Americans will leave their job at some point in the ownership experience. As for the car, chances are that the major maintenance needs have already not been performed on a three year old car when that customer is given the keys.
Will that customer remember to actually do it? Will they be able to afford to pay what it takes to get that work done?
These may seem like silly questions to those of you here who are the ‘keepers’ of their cars. However a fairly large number of folks simply get in their car, fill it with gas, and go. They don’t pay attention to the maintenance needs of their vehicles until something expensive takes place and if that something can be deferred, they will likely keep riding the car out until their money situation is healthy enough to handle it.
That’s the issue. Keepers are into preservation and low maintenance costs, which is why they keep up with their cars. The traders and perpetual debtors among us see maintenance as a thing to avoid.
If you would like a personal taste of this, go to the nearest public auction and feel free to count all the vehicles that had their major issues recently serviced. Or visit an independent mechanic shop and ask them what percentage of their customers go past the recommended intervals for major maintenance.
I am willing to bet that the number will be north of 50%, and the ones who do follow the maintenance regimen are far more likely to be long-term owners of their vehicles.
The risk of the finance company that wrote the note won’t be that much for one simple reason.
They will sell the note as part of an asset backed security to another company, which will then likely sell it to a Wall Street firm, who will then find an investment fund that is willing to buy high risk asset-backed securities.
The risk will be exported. It’s too bad that the vehicle will likely have a shorter and harder life in the process. When it comes to maintenance, most customers with bad credit simply don’t economize for it. If something goes bad on that vehicle, the only one that will have a stake in a successful repair of that vehicle will be an ‘institution’ that will be thousands of miles away, and will likely have tens of thousands of vehicles in their portfolio.
Picture Courtesy of Capital One Auto Finance – An Issuer Of SubPrime Financing To New Car Dealers
There is a lesson to be learned here. If the guy who is financing the eight year old car for three years could make more money by financing the three year old car for seven years, he would have already done it.
The fact that nobody in this business did this with high risk customers until now, means two things.
1) Either late model cars just experienced a quantum leap in improvement when it comes to overall quality.
2) Or the industry will likely have a little bit more of this type of financing until something bad happens.
By then, you will have broke customer with a broken down asset that is worth a small fraction of the remaining balance.
Does this sound familiar?
And the bubble goes “pop”.
Opportunity only knocks once but temptation leans on the old doorbell…
I would also normally say “Once bitten twice shy” but that adage doesn’t apply to Wall Street.
Basically, what I am seeing is a repeat of what caused the 2008 meltdown. People who should not be financed get financed at absurd interest rates, with crazy fees on terms that are so long the car might not make it. The note is then turned into an “asset” backed security and the risk is sold off. A downtown in the economy could send thousands of loans bad and start a domino effect. It won’t be as bad as when the housing bubble burst but it could still hurt.
It’s utter madness. Were I ever in this situation and actually needed a reasonably good car, I would be looking in the $1000 beater range until my credit rating improved. Actually, here in Soviet Canuckistan, that is what sub-prime buyers have to do as our laws make it impossible for people with bad credit to borrow money on such terms. Perhaps these are bad laws that limit economic growth but we didn’t have a crash in 2008, either.
Iceland had the right model: instead of bailing out the banks, the bailed out the customers, who retained their buying power. It was the bankers who were thrown in jail and rightly so.
It is rare that I say this to something from Canucknucklehead but I tip my hat to you Sir and say “+1.”
There is a big difference in what is going on in the sub prime auto finance world and what happened in the housing industry. In the case of cars it is relatively easy to repo a car when the payments stop. A house on the other hand is a much more expensive and drawn out process. Because of that and the fact that people need their car to get to work, the store, or doctor appts they will keep making the car payment over making their house payment. That was shown during the 08 melt down, mortgage delinquencies went up at a much higher rate than auto loans did. The other factor is that home loans were seen as zero risk because prevailing wisdom said that since real estate had been appreciating at double digit levels it would continue to, so there was not a massive adjustment in the rate for those sub prime buyers. So what if the borrower defaulted on that 300K house after a year because it would now be worth 330K so they could recover all their investment upon default and maybe more if the buyer held on for 2 or 3 years. There was also the zero and negative amortization loans with adjustable rates and often no requirement for the person to actually have the income needed to support said payment level, even the low initial payment. People who brought home 3K per month were often given loans that required payments of $2999 PTI. With the current car loans it is a different game the sub prime buyer is paying 10 times the rate and it is expected that the asset will depreciate. Even if 50% of the buyers default and of those if 50% of the remaining assets turns out to be worthless the finance company will still end up ahead vs lending money to the person with a perfect credit score that pays the shorter term loan in full.
I think the applicable term is “caveat emptor”
It may seem abusive to do this…even criminal. From a moral standpoint, it is…and I’d never be connected to a business (individual shop) that did it.
But there’s always two sides to the story. There’s a huckster looking for gulls to take advantage of; and there’s a guy with lousy credit who wants – OR NEEDS – a car.
Maybe, in the short term, for good reasons or convenient ones, such a deal appears to make sense. In any event, it’s his watch – it’s not other people’s place to assign what he can and cannot buy.
For the average broke joe, it makes far more sense to buy a beater for cash. But many average broke joes don’t think they’re average.
In any event, I got into such a situation – ONCE. Had a lower-wage civil-service job; lived on the edge of the Rockies and wanted a 4wd truck to get out in the wild. Bought new; got raped on the finance cost.
But what killed me was, eighteen months later, I got a job in a different field that gave me a company truck and required 100 percent travel. No need for that truck; and I wound up PAYING $5000 to someone to take it off my hands.
The last three cars I owned cost far less than what I could have borrowed for, at reasonable rates; but it didn’t matter, because I paid cash.
Are the banksters back to their usual tricks on “innovative Banking”
It’s true what they say..The seeds that make the next crisis are being sown in the wake of the last one.
Just remember buy at the bottom and sell before the music stops.
From the lender point of view, this may make perfect sense. Banks currently borrow at around .75% and only need to keep about 10% in reserve to the amount lended. Lending out at 22.8%, I’m guessing break even comes within a year. I don’t have a fancy spreadsheet in front of me to do the math but that’s just a quick, early morning tea drinking guess.
Yup, the bad credit buyer is just sort of renting the car. 3 year old car on a 7 year note. At probably year 4 or 5 into the note (7-8 years old on the car) something bad happens. Tranny cooks (because no fluid changes were ever done) or a head gasket goes. Stop payments, repo company comes and gets the car. Start over.
The difference from the housing situation here is that where house loans are non-recourse (the lender can take the house back but cannot chase the owner for a deficiency) car loans are full-recourse. If the 7 year old car-cass only brings $1500 at an auction and the buyer still owes $3500 on the note, he gets sued for the $2k difference. Or maybe the owner wrecks it and has no insurance. He still owes the note for a car he cannot drive.
The cycle is perpetuated. The guy keeps his horrible credit rating because he now has a repo and a judgment, and he goes back for another car.
Here’s my gripe. The safety people, the emissions people, the gas mileage people and some others have spent 30 years making cars safer, less polluting and with higher mpgs. Great stuff, except that all of this comes at tremendous cost and complexity. Nobody makes 72 Darts anymore. The problem comes down at the bottom end of the market. Bob and Betty Badcredit are almost forced into something expensive with a monthly payment because they cannot afford to buy a $1000 beater where they may have to replace a fwd 6 speed transaxle or head gaskets in a transverse V6 where there’s no room to work. Modern cars are great for the affluent and those in the middle. They are terrible for those on the bottom. I think this is why old pickups are so common in the midwest. They are the closest modern equivalent to a 72 Dart.
JP, I agree with you mostly but not with the $1000 beater part. Even if said beater lasted all of two months, heck, even ONE month, they would be better off that financing long term at usurious rates.
Speaking from experience, the problem is that sun-prime buyers tend not to be people who benefit from high levels of education and/or good judgement. The reason they have bad credit to begin with is they have not made good decisions on the road of life. Thus, when they are presented with a nice, clean, say 2005 Impala, they like it a whole lot better than a ratty-looking 1999 Cavalier, since said buyer almost definitely has no concept of their monthly obligations. For example, $7000 at 22.8% over seven years comes out at $167.46 a month. This is a significant chunk of discretionary income for low income family. In fact, I could lease a brand-new Civic for this amount, or close to it.
In fact, the interest on this loan, or even a $5000 loan, would be more than enough to buy a $1000 beater every year.
However, it doubt many sub-prime buyers are making these calculations. They only way to stop this kind of predatory lending is make it illegal. It is here in Canuckistan and I am happy for that.
Ive bought dozens of beater cars for cash when I had NO credit itinerant workers dont get credit in OZ. First up was always new oil and filters carby kit and a set of plugs leads and dizzy cap rotor if needed and thats it once running as good as I could achieve I’d just drive whatever it was until problems arose and fix it, I’m currently doing a 300,000km service on my Citroen mostly brakes and bushes an automatic accessory belt tensioner resides in the back ready for installation when I do the timing belt and the theory is I’ll get another few years out of it with regular oil and filter changes the engine runs fine and uses NO oil between changes When my daughter is gone and I can get full time employment I may consider replacing that car if it dies expensively but pirate parts are plentifull and cheap for Citroens and Peugeots so I may just keep driving it. I dont want a note
What you’re saying is true. But it sounds like you’re doing this work yourself. A lot of these sub-prime customers have neither the knowledge and capability nor the tools to do these things themselves. They’re already overextended on the loan, so there’s no money left for regular maintenance. And just as they got screwed on the loan in the first place, they will invariably get screwed by unscrupulous maintenance shops. And round and round it goes…
Yes I’m an amateur mechanic but after 40 years experience very little mechanical scares me, I learnt because I had to people like Eric and Len were out of my price range.
Hey I always took pride in the fact that I gave my customers the best value around. Sure there were the guys that would quote lower to get the customer to sign the work authorization but they always found that for what ever reason they couldn’t do it for the initially quoted price and the bottom line was always higher, much higher in the long run. There was a local place that loved to get people in the door with their $49.99 per axle brake job but low and behold once they got the car in the air and the wheels off the price was now $600 and they “couldn’t legally let the customer drive off in the car as it was because it was so unsafe”. They earned me a lot of customers sure I didn’t do their brakes for $49.99 but I didn’t try to sell them on complete front and rear brakes when all they really needed was pads and maybe rotors on the front. I also used parts that would last instead of putting on the $8 pads that were guaranteed to need replacement in 12-15K miles.
When I was young I had access to a full GM country garage workshop thats where I learned fixing cars I just got out of the habit of paying mechanics to do what I could do myself. later in life Ive repaired cars for other people and my bargain basement repairs last so they come back, unfortunately I became good at reviving VWs and where I lived Kombis abounded but I was better than the garages in town most places would refuse to touch a Volkswagen but i did repairs engine swaps and one full restoration in my 2 bay shed and happy customers all round. Now I have a car nobody but the dealer understands and me so I fix anything on my diesel Citroen saving $100 per hour.
That looks like the air filter I pulled out of my house. I don’t think the previous owners ever replaced it.
Great post. There will always be someone ready to enslave the poor.
Unfortunately, too many of those poor are that way because they’re financially stupid. And desirous of style and instant gratification. I think you’ve seen of whom I speak: $125.00 athletic shoes, and $1000 (rented) wheels on a ten year old BMW or Mercedes . . . . . . . when a five year old Chevy and athletic shoes from Pickway or WalMart would serve them quite well. And they could afford that.
If an individual tried to charge that kind of rate on money he/she loaned out it would be called outrageous. Banks and agencies do it and its called business. They live by a completely different set of rules than the rest of us. I used to think as long as I didn’t carry any debt it didn’t matter to me what interests rates such thieves got away charging others. Boy, was I wrong! Besides being unethical its the rot in the foundation of our economy. If these practices aren’t stopped one day we will be back to trading rocks and marbles.
Hopefully we’ll be trading rocks and sea shells 🙂 But seriously, I used to work in finance in both commercial and investment banking. And it’s as crooked as you can imagine. Especially the investment banking side (not that there’s too much difference now that Glass-Steagall is gone). Like they said in the Godfather, “A man with a briefcase can steal more than ten men with guns.”
Oh how true. I do not understand why people are rioting in the streets and circling the banks like Dracula’s castle.
I am sorry but while bankers might be unscrupulous and the vote buyers in the USA(aka all politicians) are quick to blame banks for everything like the housing crash nobody seems to be blaming the other group in the USA that caused it: The group of Americans that both live out of their means and also have a high sense of entitlement. In the housing collapse of 07-09, it was those folks that were making $5 an hour thinking they were entitled to have a million dollar house and took those subprime mortgages to obtain it. Then the rates and payments went up, the housing market suffered a glut of homes driving down the real estate value. The crisis set in and nobody bought anything. This caused folks to lose their jobs and homes. Suddenly folks like Jon and Joanie who live well with in their means and were good with their money now lose their jobs and home because of the irresponsibility of those folks that thought they were entitled to things they could not afford. but nobody blames them.
I am sorry but I don’t feel one bit sorry for those folks that are taken by high interest rates and bad loans. Not one bit do I feel sorry for them at all. Not when we live in an age of info and a small bit of research can guide you into something better.
I understand there are a lot of good folks that had issues like loss of job or health issues come up that ruined their credit scores but there are alot of people that just go into loans or other things with a one track mind that they have to have this or that and wonder why they only are able to get a loan for 22%
Of course banks are greedy and such BUT it takes two to tango
I think you make a good point about doing your homework to prevent yourself from being screwed. But some people that get screwed may need a bit of consumer protection. After all, when was the last time that I read a credit card agreement or a software update agreement? I could have signed away my first born and wouldn’t know. Some people aren’t educated, the elderly aren’t always 100% aware, and there’s so many folks running around taking a ton of prescription meds. But I do agree that ultimately, each person need to do their best to take care of themself.
I agree on the entitlement side. I was raised with the concept that, if you’re not flowing with money, you don’t have a right to the latest style, the current trend, and every Friday and Saturday night out partying. You have a right (assuming you work for it) to basic food, basic clothing (if its from Goodwill, so what?) and basic shelter. Anything more comes after you’ve built up enough resources to actually afford it (as in paying cash).
Yes, it sounds very depression-ish mentality. Guess that’s because I learned it from my folks. Who were of that age, and went thru it – the hard way.
Some people get their credit ruined by their family. I had a tenant that was in a place when I bought it. Calling me to tell me why the rent hadn’t been paid the caller ID showed the name of their son. In future conversations they also proudly told how the electricity and gas was in their son’s name too since they couldn’t get any of those things w/o paying up their remaining balances and a huge deposit from previous times they had left the companies hanging. Their son was about 10 at the time, not sure why the companies would give credit to a 10yo but this was 20 years ago. I’m certain by the time he was old enough to try and get credit it was already long since ruined by his parents.
Of course most people get poor credit the old fashioned way by ruining it themselves.
And when the deal fails between the customer and the bank do you realize who is going to pay the bill?? The banks have to be regulated out of the 22% business or it’s all going to come crashing down again. You don’t have to feel sorry for the 22% customers because the rest of us are going to need that sorrow as the bottom will fall out of our stock portfolios. The banks take chances and rape; if they fail we pay the bill. I am so sick of what banks have done and after reading this story would not care if they were nationalized. Now back to more pleasant car talk.
Yes. Privatized profits, socialized risks. I agree that the borrowers are not blameless, but it’s reasonable and prudent for the rest of us to set some boundaries around lenders. We all pay when “pass the trash” comes to its logical conclusion.
Anyone willing to do an article on best car designed while a car company was government owned? And the worst? Might be kind of fun…
That’s actually difficult for different reasons than you may think. Alfa Romeo and Renault were government-owned for a long time and put out nice products during that time. Just pick your preferred variant of the Giulia or you favorit Renault made in the 1950s to 1980s.
The reality is that the 22% rate being about 10X that of what a buyer with good credit can get builds in a ton of profit even if a substantial number of the marks default and leave the collateral in virtually worthless condition. So the risks to the lender aren’t really that high and thus it isn’t that likely to affect the rest of us.
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