What Do Subprime Auto Loans Have to Do With the Economy?

The stock market may be zooming toward ever new heights, but Americans are growing ever more in debt.

In fact, total consumer debt has reached a new record. As of the end of October, consumers owed $12.96 trillion, which is about $280 billion more than they owed the last time their debt reached a peak, prior to the financial crisis in third quarter of 2008, according to the Federal Reserve Bank of New York. The N.Y. Fed, one of 12 banks in the central bank system, issued a quarterly report on consumer debt on Tuesday.

One culprit? Subprime auto loans.

More people with poor credit, known as subprime borrowers, are taking out loans to buy cars, and as they do that, the level of loan delinquencies is also going up.

What’s a subprime auto loan?

The N.Y. Fed defines a subprime loan as one where the borrower has a credit score under 620.

Auto loan balances now stand at a record $1.2 trillion

A credit score is a composite based on how you use credit, including how much debt you have, your history making loan payments, and the length of time you’ve used credit, among other criteria. The lowest score is 300, and the highest is 850.

Interest rates on subprime loans are much higher than those for borrowers with higher credit scores. They can have 20% annual interest rate or more, according to reports. (The average car loan rate is reportedly about 4.2%.)

Over time, the higher rate can really add up. In fact, that could add about $12,000 in interest alone to the cost of a $20,000 car over five years, according to some auto loan calculators. That assumes a down payment of $0, no closing costs, sales tax or other transaction fees, and an annual loan interest rate of 20%.

What’s a delinquent loan?

A delinquent loan is one that’s past due, usually over 30 days. In this case, the NY Fed looked at loans past due by 90 days or more. It found 6.3 million Americans are 90 days or more behind in their auto loans, which is an increase of about 400,000 compared to the same quarter a year ago. Many of the past due loans are taken out by subprime borrowers who can’t afford to pay their loans, according to reports.

Auto loan balances, which increased by $23 billion in the quarter and now stand at a record $1.2 trillion, are a potentially worrying sign for the economy, experts say, as consumers get overextended with debt and may lack the means to repay.

That’s despite an unemployment rate of 4.1% as of October, 2017, which is near a 20-year low.

What should you do instead of taking out a high interest loan?

Shop around. Look for the lowest rate you can find. Try your local bank, as they may offer you a better deal. The N.Y. Fed points out that about 75% of all subprime loans are originated by auto finance companies, which are generally affiliated with car manufacturers and dealers.

The number of subprime auto loans, which represent about $300 billion of the total, has steadily increased over the last few years. The volume originated by auto finance companies has doubled since 2011 to $200 billion, according to the  N.Y. Fed report.