MONEY MONDAYS: Sub Prime Auto Loans And You

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    Mellody Hobson is President of Ariel investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts.  Additionally, she is a regular financial contributor and analyst for CBS news.

    Today we are talking about something that might make you pump the breaks if you are thinking about buying a car. As we have discussed before, there are some details that can get you into trouble if you are not paying attention, and this certainly qualifies – especially if you are in the market for a used car! There are currently some indicators that are pointing to a bubble of subprime auto loans that mirrors what we saw prior to the mortgage crisis in 2007 and early 2008.

    Tom:  That doesn’t sound good. What is happening?

    Well, just like the surge in mortgage lending to individuals with fair or poor credit ahead of the housing crisis, this has been driven by banks and private equity firms seeking to turn a profit off of high interest rates that people are paying on these loans. There are some other similarities to the mortgage bubble. First, many of these loans are being bundled into bonds and then sold as securities. Secondly, many of these loans have been possible through misrepresentation of income or employment, and the lenders are not aggressively vetting those individuals seeking the loans.

    All of this has resulted in a very familiar, if much smaller, subprime bubble phenomenon. The number of auto loans to people who would not qualify for traditional lower interest loans has shot up more than 130% since the 2008 crisis, with nearly 25% of all new auto loans last year going to borrowers with credit scores below 640.

    So why do I tell you this? I want to make sure that you are prepared next time you are shopping for a car, especially a used car, so you don’t end up in a financial pickle.

    Tom:  Great! So what should we know if we are thinking about a new set of wheels?

    The main thing here, tom, is to really consider your auto needs and your financial situation. My most important piece of advice: be honest with yourself. If you are tight on cash as it is, really consider whether you can afford to buy car, or if you even need it. While it is not the most fun, the best option, rather than spur of the moment, is to start saving towards that goal, rather than to get the immediate satisfaction.

    If you are in a situation where you need a new automobile, then you have to know exactly what you are getting yourself into. Consider both leasing and buying, and their pros and cons carefully, to make sure that you are protecting yourself financially. These subprime auto loans prey on lack of preparation and awareness, and they have the potential to ruin your financial future.

    Tom:  So what are the big things we should think about in terms of leasing vs. owning?

    Well Tom, the first thing to remember is that in most cases, a lessee generally draws the short straw financially, because at the end of the day when turning in the car, they don’t have anything to show for all of the payments they made. In contrast, buying a car leaves you with something of value. Lessees also really have to pay attention to the mileage limits that are included in your lease agreement. you will be charged for every mile you drive over these monthly or yearly limits, and in many cases these can be very steep – sometimes 20 cents per mile! When you look at it that way and run the numbers, leasing a car can actually cost over 25-30% more than purchasing the car.

    Now, I know everyone is thinking about all of the maintenance of owning, and that is a good point. One of the benefits of leasing means that you aren’t on the hook for maintenance – all the oil changes and tire rotations – and that is great. But if you are running the numbers to decide, make sure you pay attention to the other expenses that creep in, such as gap insurance, or penalties for driving more miles than the lease allows.

    Again, it really requires you to consider what is best for your finances. If leasing works the best for you, start by figuring out how many miles you want to drive each year, how long a lease you want and how much you want to put down. Then do some comparison shopping. Call a few different dealers and ask them to quote you a monthly payment.

    Tom: Are there options for drivers who just can make the numbers work in terms of leasing or buying?

    There are! As you may know, there are now a number of companies offering car shares, which allow for people to use automobiles for short periods of time, and they can be much cheaper than traditional car rental options. Companies such as Zip Car, Car2Go and Getaround allow people to sign up for memberships and use cars for short periods. Sometimes, they charge by hour, and sometimes they charge by mile, and these can be great options if you just need to get a bunch of supplies for a party or move furniture, and don’t need a vehicle for commuting.

    However, there are some drawbacks. The insurance on these cars can be very poor, so if you are in an accident, you may not be protected in the event that you or the other driver and passengers are injured. If you are using one of these car sharing services, you will want to make sure to get liability insurance. Additionally, the membership fees can sometimes be very high relative to the benefits if you do not use the service frequently, so you want to really weigh the pros and cons.

    Ultimately when it comes to considering your automotive needs, it is a matter of individual demands and financial sense. Usually, if you need a car for daily use, a used car is the fiscally responsible option, even if it isn’t fancy, as long as you make sure that you are able to afford it. Just don’t let a dealership mislead you. For example, most used cars will cost more up front, for the very reason that more used care loans are defaulted on. If someone tells you that you don’t need any money down, check that interest rate and get ready to run.

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