What is a Subprime Car Loan and Should You Get One?

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Do you remember just a few years ago when people with very questionable credit were able to get home loans with zero down payment?   Many of those people were unable to make their monthly mortgage payments, and the houses ended up going into foreclosure.  It ended in a national mortgage crisis.  We’re still seeing the results of that crisis.  In many neighborhoods, especially in the inner cities, there are several abandoned houses that are lowering the sales prices for the remaining owner-occupied houses.  That crisis also led to the downfall of many lending institutions, which were no longer getting a return on the investment they had made when making these loans.  And it’s led to a large percentage of these houses that are resold going to investors who rent them or attempt to “flip” them rather than to owners who are looking to put down roots and live the American dream.

Needless to say, this has worked out very well for bankruptcy attorneys over these years, but not so good for debtors trying to raise families.

Well, now, a breed of lenders has come into existence that wants to use these same tactics to encourage people with poor credit to take on auto loans that they can’t afford.   Granted, we all need transportation to get to work and to carry on our normal living functions such as the grocery store, doctor’s appointments, recreation, etc.  But are these needs worth getting into a precarious financial situation?

The ads enticing people to enter into these loans are out there:

“When you don’t have perfect credit or no credit at all, it can sometimes be very difficult to purchase a car.”

Obviously, that’s true. You may have been recently discharged from the military, or a recent high school graduate, or recently divorced, and find that because you don’t have a credit history or a good job, many lenders are reluctant to finance a car loan for you.  Or the credit history you do have may be tarnished by credit card debt, payday loans, or medical bills.  Most auto dealerships and the banks they work with prefer to give loans to “prime” borrowers, which are people with excellent credit who are likely to pay off their auto loans completely and on time.  Everyone who doesn’t qualify for the “prime” category would fall into “subprime.”

“If you have bad credit or no credit, a subprime auto loan may be just what you need to be able to purchase the vehicle you want.”

These ads try to soft-pedal the downside to subprime loans by stating that the subprime loan carries an interest rate just a little higher than that given to a prime borrower.  They explain that this is necessary to protect the subprime lender by giving them more interest since they are taking on more risk that they won’t be repaid.  Just a little higher?  In reality, these subprime auto loans can come with interest rates that exceed 23%!  And it appears that the vehicle you want will be a used car purchased from a used car lot rather than a dealership.  Further, a study by the New York Times revealed that these subprime loans were typically at least twice the value of the used cars purchased!  Even more horrendous, the study exposed the fact that, quite often, the vehicles sold to subprime borrowers had mechanical defects that were hidden from them.

It is estimated that millions of Americans are easily obtaining these subprime auto loans on cars that they cannot possibly afford in a lending market comparable to the lack of caution seen in the housing industry before it collapsed in 2008.  In fact, auto loans to people with tarnished credit have risen more than 130% in the past several years, with an estimated one in four new car loans last year alone going to subprime borrowers.  These loans can push borrowers who are already credit-challenged further into debt, even leading some into bankruptcy.

You are probably aware that if you can’t make your car payments, the lender can repossess the car.  It is then taken to auction and sold for the best bid.  The sale of the car doesn’t get you off the hook with the lender unless somehow the sale price equals what you owe on the loan, and most times, it’s not even close.  The lender can still hold you responsible for the deficiency between what you owed on the car and what it sold for, plus the costs of picking the car up and the sale itself.  Once that sale is completed, the deficiency balance will be reported to the credit reporting agencies, and it will show up should you try to finance another vehicle.  So your effort to provide yourself with a new vehicle using a subprime loan might end up with you owing on that car and still having no vehicle in your possession.

It seems strange, but actually filing for bankruptcy could help you out in that situation.  If you don’t have the cash to pay the deficiency balance, it can be discharged in a chapter 7 bankruptcy.  Since you cannot file another case under chapter 7 for 8 years from the filing date of the first one, the future car lender will know that you’ll have to be responsible for payments and/or another deficiency balance for that length of time.  So the risk to a future lender is less than it would be without bankruptcy, and the interest rates should reflect that lessened risk.

How can you protect yourself from subprime lenders?

1)  Be suspicious when you see ads that seem to make it so easy to borrow money on a car when your credit is not the best.  They will make it sound like they’re lending all day long to people whose credit makes yours look excellent.  They’re sympathetic to your circumstances and are all too willing to help you buy the car of your dreams.

2)  Read the paperwork on a proposed car loan very carefully before you sign.  Make sure you look for the interest rate you’re being charged.  It certainly shouldn’t be as much as 23%!  If it’s not clearly indicated on the paperwork, walk away from the deal.  You’re being taken advantage of by the lender.

3)  Before you purchase a used car, do your own research on NADA or Kelley Blue Book to see what the car is worth.

4)  Also, take the car to a trusted mechanic to check it out so that you are aware of hidden defects you might otherwise not see.

5)  You are always better off if you can purchase a car with cash rather than a loan, even if what you purchase is not what you really want.  If you make a costly mistake with a subprime loan, it will keep you even longer from owning the car of your dreams!

If you have more questions about subprime car loans and whether or not to get one, contact an experienced attorney at Horwitz & Horwitz today.

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