Why Americans Are Falling Behind On Car Loans

Whether it’s a sports car you’re excited to rev up for a nice weekend drive, or a safe minivan filled with entertainment features for your children, cars are everywhere. There are more than 275 million vehicles on the road in the United States. People equate cars with freedom.

There is a way in which cars give us an ability to explore, see, and expand our lives. But in recent years, owning a car has gotten expensive, really expensive. More than 100 million Americans have an auto loan, and auto loan debt in the U.S. is currently at $1.5 trillion dollars – a record high. Outside of purchasing your first home, a new car or an auto is the second largest purchase for most people.

Given the transaction prices and vehicle prices today, financing is required to buy these vehicles. In 2023, the average monthly auto loan payment for a new vehicle is $725, up from $650.20 in 2022. The average monthly payment for a used vehicle is $516 in 2023, up 2% from the prior year. Meanwhile, consumers don’t typically cast their car buying experience in a positive light.

“It was a very quick process. And I did feel like they just wanted me to sign at the bottom line as quickly as possible,” one buyer mentioned. For years, complaints and lawsuits have been popping up left and right against lenders for alleged discriminatory and illegal practices. It undermines trust, despite assurances from lenders that their priority is to consumers.

Understanding the Auto Loan Industry

An auto loan is a lump sum of money given to purchase a car that must be paid back over time with interest. Once approved for a loan, often including a down payment, you can drive your newer used car out of the lot, but it’s only yours as long as you make monthly payments. For example, 32-year-old Sean Miller bought a new car in 2019 for just over $48,000. He put down about $10,000, locked in a 3.89% interest rate for a 72-month term, and now makes monthly payments of about $590. By the time the loan is paid off, he’ll have paid nearly $5,000 in interest. Until the loan is fully paid back, the lender holds the title and can repossess the car if payments are missed.

There are direct and indirect lenders. A direct lender would be your local bank, credit union, or an online lender. Once approved for a loan through a direct lender, you can then head to the dealership and shop around for your car like a cash buyer. Indirect lending, however, occurs when you go to a dealer and they provide you with financing options as you’re buying a car. About 80% of auto loans are estimated to be indirect.

Regardless of if you’re choosing a new or used car or direct or indirect lending, one of the most important factors determining the interest rate and loan terms is how confident the lender is in your ability to repay the loan. They look at your assets, liabilities, income, expenses, and most importantly, your credit score. Chase Auto, for example, services consumers with a credit score of 620 and higher, with the average credit score typically in the 700 range. Toyota Financial Services holds primarily a prime credit portfolio, meaning they service those with very high credit scores, with an average score of 744.

The Auto Loan Market

Toyota is currently the market leader for auto loans and leases. In 2022, 5.3% of total auto financing came from Toyota Financial Services, while 4.4% came from Capital One Auto Finance. Toyota’s financial services business consists primarily of providing financing to their own dealers and customers. Sales revenue for the financial services business for the fiscal year ending in March 2023 increased by nearly 21% to 2809.6 billion yen from 2022, which is about $19.8 billion.

The auto loan industry is going strong with consumers buying vehicles and the demand for lending. However, the chip shortage and soaring inflation rates are challenges. More than half of auto financing is by non-bank finance companies, such as the financing arms of automakers. These lenders typically rely on short-term funding markets for their own financing, which can be volatile.

Rising Interest Rates and Car Prices

In the first quarter of 2023, the average interest rate for a loan on a new vehicle reached 6.58%, up from 4.1% in 2022, marking a 15-year high. Average car prices are also at a high due to supply chain shortages, higher demand, and inflation. This means Americans are taking on larger loans at higher interest rates. In the past 10 years, outstanding loan debt has doubled, reaching a record high.

Younger Americans are more in trouble than ever. In 2020, $20 billion in Gen Z and Millennial debt had fallen into serious delinquencies. Many, like Miller, find themselves struggling with car loans they can’t afford to keep up with. Lower-income consumers, particularly those with credit scores below 620, are hardest hit by the Fed’s interest rate hikes, which are squeezing them out of the market.

Discriminatory and Illegal Practices

The auto loan industry has faced numerous complaints and lawsuits related to alleged discriminatory and illegal practices. For example, the Massachusetts Attorney General reached a $7.6 million settlement with Toyota Motor Corporation to resolve allegations of illegal auto loan collection practices. The lawsuit claimed Toyota failed to give consumers sufficient information about the calculation methods for deficiencies left on their auto loans after repossession.

In 2016, a $21.9 million settlement addressed allegations that Toyota discriminated against Black and Asian borrowers by charging them higher rates than white borrowers. This issue is not unique to Toyota; many major car manufacturers have faced similar lawsuits. Reports, including one by a former senior economist at the Federal Reserve Bank of Chicago, claim that Black, Hispanic, and Asian borrowers often pay higher loan payments than their white counterparts.

A class action lawsuit in 2017 alleged Chase Auto violated the Fair Debt Collection Practices Act and state law by illegally repossessing consumers’ vehicles. In 2018, Chase Auto, JP Morgan Chase, and a debt collector settled the case for $3.25 million. Chase Auto has since implemented various systems and processes to ensure compliance with rules and regulations.

Proposed Changes and Consumer Recommendations

In 2022, the FTC proposed a rule addressing unfair and deceptive financing practices by auto dealers. Proposed measures include banning bait-and-switch claims, fraudulent junk fees, surprise junk fees, and requiring full upfront disclosure of costs and conditions. However, in July 2023, the US House Appropriations Committee backed a government spending bill containing language that blocks the FTC from implementing its proposed new rules.

Consumers need to be vigilant. Before getting an auto loan, experts recommend shopping around, checking your credit score, getting pre-approved online, and comparing rates and terms. Credit unions often offer lower interest rates compared to banks. Utilizing digital marketplaces and tools, like Toyota’s SmartPath, can also help in making informed decisions.

Conclusion

The auto loan industry is complex and fraught with challenges for consumers. High interest rates, rising car prices, and discriminatory practices are significant issues. Consumers must arm themselves with information, shop around, and be prepared to negotiate to ensure they get the best deal possible. Transparency in lending practices and consumer protection measures are crucial for a fair and equitable auto loan market.