Monday, February 11, 2013

Subprime kind of life

Subprime lending came into the national spotlight during the financial crisis. If you've heard of subprime lending, you're probably already thinking about subprime mortgages and not lending itself. There was a crackdown on subprime mortgages after the financial crisis. But, subprime lending, in general, has not gone away. In fact, when we look to subprime lending for auto loans, we're looking at a fairly lucrative and growing industry.

Subprime lending: also known as near-prime, non-prime, and second chance lending. Subprime lending gives loans to people who have impaired or limited credit. They are typically people who have credit scores of 679 or lower. The loans themselves are characterized by higher interest rates and less favorable terms for the person who has the loan to make up for the perceived credit risk. Subprime lending is attractive to consumers because, very often, the people who take these loans are people who would not be able to get a loan in the first place. These loans are attractive to banks and financial institutions because they are able to charge higher interest rates.

With lower interest rates, banks are able to get more money, more cheaply. As a consequence of that, they want to make as much money as possible. While handing out steady loans to people who qualify for lower rates might get some money, a higher interest rate on a similar loan will get more money back. With the restrictions and rules in place, it's not hard to see why financial institutions are willing to hand out subprime loans. Not only that but financial institutions and consumers have lowered their debts. So now even a subprime loan is not as risky as it once was. In the first quarter of 2012, Experian found that just 0.57% of auto loans were delinquent in the first 60 days. In 2009, that number was 0.78%. In the third quarter of 2012, Experian found that the third quarter delinquency rates for both 30 day and 60 day were below pre-recession levels for two years. The delinquency rates are lower, so banks and other financial institutions are more likely to give out these types of loans. The third quarter of 2012 showed that 42% of new and used car loans were given to subprime buyers compared to 40 percent a year ago. In 2007, 43% of new and used car loans were subprime. We can look at it another way, too.

If you're in the super prime group (740 or higher), your average interest rate for a new car would be 3.2% and 4.4% for a used car. If you're in the prime group (680-739) then your interest rates for a new car would be 4.5% and 6.4% for a used car. Nonprime (620-679), now we're looking at 6.5% and 9.5%, respectively. Subprime (550-619) are looking at 9.9% and 14.4%. Well, how about even lower (549 or lower), well then it averages12.8% and 17.9%. But, honestly, who is paying these rates?

The demographics for those who fit into one group are a little shady. But if we look at how subprime lending was happening before the financial crisis, we might be able to glean some information about who is receiving these types of loans. The Center for American Progress found that 17.8% of whites were given these types of mortgages from major banks in 2006. You can compare that to Asians at 11.5%. Or you can compare it to Hispanics at 30.9% or African Americans at 41.5%. If you look at the data closer, with high income borrowers, to compare like income you see that whites (10.5%) were about three times less likely than Hispanics (29.1%) and African-Americans (32.1%) to receive these types of loans. The caveat to this is that underwriting for a home is going to deal with more than income, including credit scores, assets, loan-to-value ratios, and other indebtness. So, it would be hard to conclude just from this study that these loans are given out just to minorities. But it gives us something to look at.

African-Americans are often described as being flush with cash. I mean that literally. African-Americans, for whatever reasons, don't tend to be loaded with credit and savings. It makes sense that they would have lower credit scores thus impacting their ability to fit into a category that will help them secure a nice loan.

Undocumented immigrants tend to have lower credit scores because it is harder for them to secure credit. While a lot of them have the ability to get a bank account, depending on their banks' partnerships within their home country and their identification card from their country, they often times don't. Certain banks, like Wells Fargo, has done marketing to try and get undocumented immigrants to bring their cash into the bank. Bringing this money to the bank can result in being able to pay bills through credit, establish it, and help credit scores grow. This, in turn, may lead to a decrease in the amount of subprime loans being handed out. Now, if you're an undocumented immigrant and you see a commercial offering loans for people with bad or no credit, of course you're going to jump on that offer.

Banks and consumers do like subprime loans for different reasons. These loans might even be helpful if they're used properly, like their supporters suggest. While these loans will continue, regardless of any actions taken, the immigration reform debate might lead to a decrease in these numbers, simply by allowing undocumented immigrants a chance to build credit. What's often lost in the immigration reform debate is that immigrants are actual people. People have needs and desires of their own. Allowing immigrants to be citizens might just reduce the number of subprime loans being taken out, mitigating the risk for both the consumer and the financial institution.

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