Mellody 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.
Tom: We are covering another development on the auto loan front this morning. What do you have for us?
Mellody: This is one is a doozy, tom. We have talked about numerous controversial practices on this show, and we have talked about subprime loans before too, but this really may take the cake. The news came out last week covering a new practice being used by lenders to make sure people are keeping up with their auto loan payments: if you don’t pay, they can remotely prevent your car from starting or even turn it off while you are driving it!
Tom: Wow. You are saying they can just turn off your car?
Mellody: Yes, and some of the results have been jaw-dropping. One woman alleges that her car was shut down on the interstate. She later reached a settlement with the lender. So what is motivating such a drastic practice? The demand for securities backed by these subprime loans, which have high returns. The devices have allowed lenders to bring ever-higher risk borrowers into the lending market, fueling the subprime auto loan boom we talked about a little while ago. So, while these individuals are getting access to cars, they do so with a big caveat: at the touch of a button, they can lose control of the car, literally, since lenders have the ability to simply shut it down. Borrowers must stay current with their payments, or lose access to their vehicle.
Tom: How many people are impacted by these devices?
Mellody: Well, the auto market has been booming over the last year or so as people have sought to upgrade their cars after years of holding on to them. And the proportion of subprime auto loan market is huge. New auto loans reached $371 billion in the year to June, up 7.4% from the previous year and 64% since 2009. Subprime auto loans, made to the riskiest borrowers, have grown even faster, by 93% since 2009, and a full 25% of loans last year were subprime. In terms of numbers, numerous reports state that these devices have been installed on nearly 2 million cars.
Tom: Wow. This is really shocking! Two million – this is affecting a lot of people. Tell me, what qualifies as a subprime loan?
Mellody: Subprime refers to loans to borrowers with credit scores below 640. These loans are generally defined as having very high interest rates – in some cases as high as 29% – and being largely extended to lower income brackets. Because of the racial wealth disparity in this country, that means that subprime loans disproportionately impact the black community, and when a subprime bubble bursts, it can be devastating. And with the aggressive use of these devices to extend more subprime loans to ever-higher risk borrowers, we may yet see a big bubble develop.
Tom: So what can we expect to see next?
Mellody: thankfully, i think we can expect to see regulators look at this issue very carefully, because of the vast array of concerns that surround it – whether that is safety concerns, privacy concerns, civil rights questions or simply risky financial practices. After all, this would certainly seem to fall under the purview of when and how bill collectors can contact you, which are regulated.
This is an example of how technology is increasingly being used by companies to lessen the distance between themselves and their customers, even when it is to a very uncomfortable degree, in order to create secure cash flows. Device makers have asserted that late payments have dropped from 29% to 7%, so there is definitely an incentive to have them installed and allow them to capture high payments. So for now, they are likely here to stay.
Tom: So what should we do about getting a car?
Mellody: Do not buy a car if you cannot afford it. Like i mentioned a few weeks back, the most important thing is to really consider your auto needs and your financial situation. If you are tight on cash as it is, really consider whether you can afford to buy car, or if you even need it. The best option is to save towards a goal, rather than to get the immediate satisfaction. I cannot reiterate this enough: these subprime auto loans prey on lack of preparation and awareness, and they have the potential to ruin your financial future.