Subprime borrowers faltering on payments

Rising car prices and the end of the pandemic-era stimulus may be causing the nation's most vulnerable borrowers to struggle with their loan payments, the Consumer Financial Protection Bureau has concluded.

A recent CFPB report found auto loans originated in 2021 have a delinquency rating of 0.67 percent in the sixth quarter following their origination. This is 13 percent higher than loans originated in 2018.

While nearly all groups are seeing an increase in delinquencies, consumers with subprime and deep subprime credit scores — those between 540 and 619 and below 540, respectively — are getting hit the worst. For example, loans originated in 2022 by this group had a 2.4 percent delinquency rate after the first two quarters post-origination. This is a 33 percent increase from a previous high seen in 2020, according to the CFPB.

Ben Litwin, a financial analyst at CFPB and co-author of the report, said the easiest explanation is the rise in car prices seen nationwide.

"The consumers who have the lowest income are seeing delinquencies rise faster than consumers with higher incomes," Litwin told Automotive News. "That point specifically seems very intuitive."

There are more factors at play, though. The end of the pandemic-era stimulus is also partially to blame, according to Litwin.

"Lender after lender that we talked to would echo that," Litwin said. "There has been an increase in delinquencies around the end of different stimulus programs — whether that's the one-time payments or expanded unemployment."

It's not as black-and-white as that money going directly to car payments, according to Chris Kuklas, the senior markets and policy fellow at CFPB and the other co-author of the report.

The stimulus, despite most forms being gone for more than a year, allowed lower-income consumers to build up savings. As payment amounts increased, those accounts began to be drained.

"What people started to do was to draw down on those cushions," Kuklas said. "What we're beginning to see over the last few months are families starting to hit the point where they've spent down that savings they were able to build because of the financial stimulus that had helped keep them afloat."

Contrary to popular belief, rising inflation across the country is most likely not contributing to the rise in delinquencies, Litwin said.

While the higher costs will strain a family or individual's monthly budget, a car payment is usually not the first bill to fall behind on because of a vehicle's importance.

"For most Americans, if you don't have a car, you can't get to work. You can't take your kids to school," Litwin said. "I don't want to say how much inflation is directly affecting a consumer's ability to pay for their auto loan, but it is going to force consumers to stretch their monthly budgets."

There is an upside to the rise in delinquencies — it could just be a normalization of the market. Many lenders Litwin and Kukla talked with said the rates were merely returning to what they were before the COVID-19 pandemic when they were notably trending upward of 5 percent.

Another upside is what Kukla calls an "escape hatch" many borrowers — specifically used-car owners — still have because of high resale values.

Some consumers can extinguish a large part of their loan by selling their vehicle because lenders earn more money from that outcome than if they repossessed the vehicle and sold it at auction, said Kukla.

However, if used-car prices continue to drop, this solution could close and put consumers falling behind on their payments in an even worse position. These subprime and deep subprime borrowers, who had poor credit scores to begin with, could end up with a repossession on their report.

This outcome, Kukla said, also negatively affects lenders. The reason the current escape hatch works is because lenders are able to get their money back and borrowers are able to extinguish their loan. If a lender has to repossess a vehicle that has decreased in value, it impacts the way they do business.

"If you got a loan that's supposed to be secured by a $40,000 car that's now secured by a $20,000 car, you have a little less leverage," Kukla said. "What does that mean for what the lender does after the repossession?"

As for when or if this scenario happens, the CFPB tries not to make predictions.

"Pretty much every month, we hear in about six months the supply chain issues will get better," Kukla said. "I think this is a really challenging question to answer. It's one that has pretty significant impact on the market, and certainly for consumers."