Lenders make money from the interest earned from the amounts loaned. As some of the potential market may not meet the requirements so as to qualify for loans, lenders award loans to borrowers who have some credit impairments such as little or no credit history and low credit scores. This designation is called subprime. The term ‘subprime delinquency’ is not new in the financial world. The definition of the delinquency rate is the percentage of subprime loans which are delinquent after 60 days or more.
In late 2006 to early 2007, there were signs of the subprime mortgage crisis. However, in 2016, it is clear that subprime delinquency on the rise. It was confirmed by Goldman Sachs that subprime loans have led to the collapse of auto sales, and that it was a result of people taking out loans on their cars and losing money in the markets, reducing their ability to buy new cars.
Subprime loans came about so as to cater for the market which needed funds, but did not qualify the criteria. Therefore, the lenders became more lenient with their standards, such as setting lower FICO scores, so as to award more loans. With this, the rate of delinquency increased over the years. Borrowers were also encouraged to take up auto loans and then put the funds in the stock market during the peak times.
A large number of the borrowers who took auto loans failed to pay. This trend has been on the rise and it is reflected by the losses made by the top participants of subprime lending. As of the third quarter of 2014, the following were the top category of participants: financial institution such as credit unions, captive and banks. The top lenders were Santander Consumer USA, Capital One, GM Financial, Wells Fargo, Ally Financial, Credit Acceptance Corp, Exeter, Consumer Portfolio Services, Westlake and Huntington, among others. However, the auto firms such as Ford, GM and Chrysler are most exposed to subprime delinquency. They account for almost half the amount of the subprime market in the US.
Factors such as high loan to income ratios, lack of documentation, resetting of the adjustable-rate loans and lower credit standards were attributed to have caused the subprime mortgage delinquency. Such factors should be looked into and lenders ought to carry due diligence while considering potential borrowers. In as much as they would like to widen the market, care should be taken so as to reduce the rate of subprime delinquency.
So, is it all gloom and doom? The Goldman Sachs report suggested that since subprime loans tend to have higher markups, subprime focused dealers could be pressured by increased regulation. Such regulations should increase compliance costs. The subprime mortgage bubble grew and burst and now, all eyes are on that of the auto industry Henry I don’t get this. If compliance costs increase this will push up the costs of loans. How is that good for anybody?