> Posted by Nadia van de Walle, Senior Africa Specialist, the Smart Campaign
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The risks associated with the recent U.S. boom in subprime auto loans for the working poor are compounding, a series of articles recently published by The New York Times indicates. The articles report on the Times’ extensive investigation on the subject, which included the examination of over 100 bankruptcy cases, dozens of civil lawsuits against lenders, and hundreds of loan documents. The series draws attention to companies lending to those on the financial margins who often have questionable or missing credit histories and who are purchasing typically pretty old, low-quality cars. Lenders have lowered credit standards to widen their pool of borrowers, a risky practice incentivized by an influx of money from investors looking for a hot market and keen to securitize. Subprime auto loans have increased by 130 percent in recent years, and in 2014 they accounted for one in four auto loans.
In addition to viewing this through our did-we-learn-nothing-from-the-subprime-mortgage-crisis?! glasses and seeing potential systemic repercussions, one can take the consumer rights vantage point and see the scary picture of a world in which the underbanked or financially excluded are given two kinds of options: bad and really bad. We decided to score the features of this market against the seven Client Protection Principles of the Smart Campaign. Since the Client Protection Principles are a do-no-harm standard, we expect markets to meet seven out of seven principles to earn our endorsement. Let’s see how subprime auto loans stack up.
First, as the articles highlight, customers in this market often find themselves very quickly, severely in debt and thus the principle of Prevention of Over-Indebtedness is not being met. These lenders bypass even basic repayment capacity analysis, and apply lax credit standards. In some cases, consumers who are bankrupt, without jobs, and even living on social welfare programs receive loans they cannot afford– as their employment information is falsified by car salesmen. Score: standard not met.
The principle of Appropriate Product Design and Delivery Channels is also missing in action. Some of these loan products are designed such that the loan size for a run-down used car – whose defects are also not adequately disclosed to the consumer – is greater than the value of the car. In The New York Times’ examination, it was found that the size of the loan was typically more than twice the value of the car. Buyers drive off the lot and straight underwater. In the case of the title loan market, used by 1.1 million households in 2013 to obtain fast cash in exchange for their car titles, inability to keep up with repayments, quickly leads to repossession of the car. Because the cars resell for an amount smaller than the loan principal, the now carless borrower may still be paying off the debt years later. Score: standard not met.
Recent press describes many cases where the principle of Transparency in this subprime auto loan market is not being met. I’m curious to see a deeper exploration of disclosure mechanisms, but the Times’ series documents instances of purposefully murky communication, linguistic barriers, misunderstood contracts, and customers who do not feel comfortable asking questions. With these auto loans, car dealers are in effect the agents of the finance company that extends the loans. Given their incentives – to sell more cars – and their training – focused on automobiles, not financial services – they are not reliable sources of information. Score: standard not met.
On Responsible Pricing, the series devotes an article to the high interest rates charged. For some of the loans inspected, interest rates were as high as 29 percent, with the occasional incidence of excessive fees and add-on products required for loan purchase such as high-cost insurance policies. Score: we can’t judge without knowing more about the costs of making such loans, but we do know that prime customers receive significantly lower rates.
The series’ articles also expose how the principle of Fair and Respectful Treatment of Clients is infringed by lenders using devices that can remotely disable a car’s ignition the minute a borrower misses a payment. One of the articles quotes Robert Swearingen, a lawyer with Legal Services of Eastern Missouri, in St. Louis, who says: “No middle-class person would ever be hounded for being a day late. But for poor people, there is a debt collector right there in the car with them.”
Along with falsifying employment activity, lenders and car dealers in this market have been found to use aggressive sales techniques and poorly treat desperate clients who absolutely need cars to get to their jobs. For instance, the Times recounts lenders misleading borrowers on their loan qualification such that they will jump on whatever is offered, even if the terms are contrary to their interests. Score: below standard.
With tie-ins to the Campaign’s Client Protection Principle of Privacy of Client Data, these devices point to the double-edged sword of big data. While such surveillance and personal data gathering can be troubling, lenders are also framing such technologies as a way of understanding and evaluating customers who have no credit history, thus allowing them to serve the underserved. Score: questionable.
Finally, if a borrower wants to argue about falsified information, repossession, or another grievance, they by and large do not have any mechanisms for complaints resolution – the final Client Protection Principle. When a borrower goes to the bank for recourse, the reporting shows, the bank tells them this is a problem for the dealer, who then sends them back to the bank. Score: standard not met.
In summary, the U.S. subprime auto loan market fails to live up to every one of the Client Protection Principles. There is something seriously wrong here. It is no surprise that the auto loan industry negotiated an exception for itself from the consumer protection provisions of the Dodd-Frank reforms. Hopefully, these issues will continue to be examined in the news and by consumer advocates. In the meantime, these consumer violations of the Client Protection Principles provide another example of the high cost of being poor. Financial inclusion cannot be a matter of including the poor only in so far as they are willing to receive bad treatment, higher fees, and be left carless and in debt.
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