Most of the time, consumers can expect interest rates on automobile loans to rise and fall in line with all other interest rates.
But a behind-the-scenes shift in the automotive financing industry has changed that, at least for the moment, making shopping for the best interest rate deals more important than ever.
Auto loan interest rates are currently out of whack, running slightly higher than usual, and banking experts are not sure how long it will be before they fall back to “normal” levels.
Securitization is to blame
The culprit is a trend toward securitization of auto loans. Securitization happens when an auto finance lender groups loans together to sell on the open market as a bond-like security paying interest and principal to investors.
Many banks and other lenders will make many car loans, then sell an entire package of such loans. When the car loans change hands, the bank gets money it can use to make more loans. The buyer of the package of loans then takes over collections.
Many consumers are already familiar with such moves because at one time or another they have found themselves making mortgage or student loan payments to a new lender after the original lender sold their loans.
These practices are becoming much more common in auto lending as well, which gives borrowers one more thing to worry about.
James Verbrugge, a banking expert and chairman of the finance department at the University of Georgia, said consumers can take a variety of measures to protect themselves from the higher auto-loan interest rates.
Understanding where the various sources of credit are is an important first step. The best interest rate deals usually come from a home equity line of credit. “Generally you will not get a better rate,” Verbrugge said.
Consumers can sometimes get better terms from banks or credit unions than they would from the automobile dealerships, and it is best to research rates ahead of time instead of automatically financing through a dealership, Verbrugge said.
“Typically you’re going to do better to keep the buying decision and the credit decision separate. Don’t let the financing decision be done by default,” he said.
Risky loans driving costs up
As more money flows into the auto financing market, lenders are extending credit to a growing number of consumers, including many who normally would have trouble getting financing because of poor credit histories.
“We’ve extended lending and, correspondingly, securitization, to higher risk consumers,” said Verbrugge.
As a result, lenders are charging higher interest rates to cover the increased costs associated with high-risk borrowers, who are more likely to default on a loan. While much of the increased cost gets passed on — in the form of higher interest rates — to the individual consumers who have poor credit histories, some of the costs are affecting the auto credit market as a whole.
Rates no longer waltz together
Auto loan interest rates still fluctuate just as other interest rates do, but they are currently out of kilter with the rest of the market. While they once moved in tandem with Treasury security interest rates, they no longer decline as rapidly as they once did when other interest rates drop.
For the 13 months ending in January, the four-year Treasury rate fell 85 basis points, from 6.25 percent to 5.4 percent. At the same time the four-year auto loan rates declined only 5 basis points, from 9.3 percent to 9.25 percent.
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“Because the risk profile has increased, that caused the break in the relationship between Treasury rates and interest rates on auto loans,” said Keith Leggett, senior economist at the American Bankers Association in Washington, D.C.
It may get better later
In the long run, securitization is expected to lower interest rates by increasing the amount of cash available to borrowers. The securitization boom in the mortgage market began in the early 1980s, and average mortgage interest rates are now 0.75 percent lower, Leggett said.
However, no one knows how long it will take the financial markets to absorb the changes in auto lending and produce lower rates, Leggett said. Right now securitization is having the opposite effect.
The securitization trend is being fueled in part by the success of specialized finance companies that compete with banks and auto company financing subsidiaries.
These companies are extending credit to people who previously had trouble qualifying for auto loans, said Dan Berce, chief financial officer at AmeriCredit Corp. of Fort Worth, Texas.
Berce said his company, which is the largest in its industry, specializes in lending to higher risk consumers. Interest rates on the car loans range from 10 percent to 24 percent, with the average being 19 percent. Most of the loans are for used cars, with about 15 percent going for new vehicles.
Risky doesn’t mean poor
While the average AmeriCredit borrower has a healthy household income of $42,000 annually, the group includes many people who filed for bankruptcy at some point or fell behind on credit payments as a result of job loss, divorce or some other problem, Berce said.
“There’s many more people in the ’90s who have declared bankruptcy or had impaired credit,” Berce said.
While the current situation in auto lending is creating slightly higher interest rates for consumers, the bright side of the picture is that people who may have been denied credit in the past can now get financing.
Berce of AmeriCredit also noted that people who have had a financial setback but have good recent credit histories will get the lower interest rates from his company.
“We determine pricing based on risk.”