Subprime car loans -- loans given to people with bad credit -- are now being packaged into securities that are being scooped up by investors, according to a recent report by the Los Angeles Times.
These loans, given by independent used-car dealerships who promote their businesses as "buy here pay here" are highly profitable because the cars are sold to consumers at well above book value at high interest rates for a car loan. There is growing concern that the practice will cause these dealers to loosen their lending practices further. This would lead to an increase in these types of loans, which would in turn increase the default rate, possibly causing a collapse similar to the mortgage-industry debacle of a few years ago.
The default rate for these types of car loans is about 25 percent, according to the Times report, but the securities that house these loans are generally rated very high as investments because the ratings firms feel that the sheer quantity of loans within the securities makes them safe.
While independent used-car dealerships offering the "buy here pay here" option may seem like the best choice for a car shopper with bad credit, the consumer who pays off one of these loans ends up spending a large amount for very little car. The sale price of the car is higher, often by thousands, than the car's actual value, and the interest rate on the car loan is extraordinarily high. Car shoppers in this situation would be better suited to seek a personal loan from a friend or family member or improve their credit first and then apply for a loan with a conventional lender.
Tara Baukus Mello writes the cars blog as well as the weekly Driving for Dollars column, providing both practical financial advice for consumers as well as insight into the latest developments in the automotive world. Follow her on Facebook here or on Twitter @SheDrives.