Why Auto Debt Sucks.
We Owe More On Cars Than Credit Cards. That's A Problem.
Sometimes the things we consider helpful in life actually end up doing us harm. I'm looking at you, way-too-convenient fast-food place near my house.
For millions of Americans, another example of this is the car loan. Since the beginning of the auto industry, it’s been how most of us who don’t have a spare $35k in our money clips can afford a vehicle. But have you ever examined what you’re really taking on when you agree to an auto loan—or how perilously deep this river of debt actually runs?
Auto debt is just as pervasive as credit card or student loan debt, with Americans currently owing about $1.27 trillion in car loans. That’s slightly more than they owe on credit cards ($1 trillion) and not much less than they owe in student debt ($1.48 trillion).
And while we see constant news stories about the burden of student loan debt and how to manage what we owe on our credit cards, there’s far less conversation around the potential dangers posed by auto loans. For example, a Google search I ran last week for “auto loan debt” brought up 176,000 results. Meanwhile, a search for “student loan debt” brought up 3.93 million pages—more than 22 times more despite their roughly similar financial scale.
Let’s look at the four largest forms of debt in America to break down how auto debt stacks up—and whether it deserves a more critical look from consumers.
Home Loans ($13.21 trillion)
With the obvious exception of the lending excesses that led to the 2008 housing crisis, home loans are typically considered a prime example of “good” debt.
For one, a home generally goes up in value as you own it—which is pretty much the only reason you should ever go into debt to buy anything. Better yet, if this appreciation outpaces the interest rate you’re being charged on your home loan, you actually get paid to be a homeowner.
Second, mortgage debt is backed by an actual asset—your house. This is very good for both you and your lender. It means you literally get to live in the thing you’re paying off, and makes writing that check each month feel just a bit better. It also means the bank can protect itself by being able to easily recover the house if you default—a level of certainty that allows mortgage lenders to charge you much lower interest rates than those that come with most other forms of debt. Up to a certain level, the interest on your mortgage loan is also tax-deductible. Like I said, not bad at all.
Interest Rate: Low (3-5%)
Delinquency Rate: Low (4.8%)
Flexibility: High. Home refinancing is literally an industry unto itself, giving homeowners a variety of options should they need to change the terms of their loan.
Verdict: The good-to-have debt. Despite past abuses, the numerous benefits of home ownership make a mortgage one of the most beneficial forms of debt around.
Student Loans ($1.48 trillion)
As college costs continue to skyrocket—from an average of $13,000 per year in 2000 to more than $26,000 in 2016—access to higher education is increasingly provided by student loans.
Because student loan debt is so massive, regulators recognized early on that it represented a serious potential danger. As a result, the federal government inserted itself as essentially the only player in the student loan business and put some solid guardrails around the practice to ensure that just about anybody can get a student loan at a reasonable rate. For students who show financial need, this interest is even covered by the government via subsidized loans until that student graduates and can enter the workforce. Like home loans, the interest on federal student loans is often tax-deductible—up to $2,500 a year.
The big problem with student loan debt is simply the sheer amount of it that must be incurred by many students to meet rising tuition levels—often running well into the six figures. True, student loans have the inarguable benefit of unlocking millions of successful career paths. But making a decade or more of payments to cover an experience you had in your distant past doesn’t exactly have the same warm buzz of paying for a house you get to inhabit as you sit back and watch it steadily appreciate.
Interest Rate: Medium (5-6.5%)
Delinquency Rate: High (11.2%)
Flexibility: High. Interest is often deferred until after graduation and loans can be consolidated or even have their payments postponed without losing standing. There are even student loan forgiveness programs for workers in certain fields or with certain levels of debt.
Verdict: Bad because it’s big. Despite reasonable rates and significant methods for flexibility, the massive size of student debt and its high delinquency rates rightly earn it a place as one of the most burdensome forms of debt.
Credit Card Debt ($1 trillion)
Perhaps the most dangerous thing about credit card debt is how easy it is to access. Most people can easily get their hands on a card to front purchases they don’t have the cash for and quickly fall into trouble.
To be clear, surviving any kind of debt largely depends on the interest rates. Paying down the principal on rates of 4 or 5 percent can amount to a manageable jog for some people; for others, a brutal uphill climb. But at 10 percent, getting out of debt becomes like trying to outrun your shadow—no matter who you are. At that point, a $120,000 loan would have you paying $1,000 a month in interest alone.
But here’s the real messed-up part: The average credit card interest rate in the U.S. currently stands at a staggering 13.64 percent. Of course, they go much higher than that. In fact, some of the top cash-back cards can carry APRs of up to 29.99 percent.
But credit card debt does have a couple of key saving graces. For one, you’re only exposed to interest rates if you carry a balance on your card. And two, there’s no shortage of loud and repeated warning signals about its significant dangers.
Interest Rate: High (Up to 29.99%)
Delinquency Rate: Low. (2.47%)
Flexibility: High. You can avoid interest charges altogether by paying off your credit card each month and even transfer your debt to a lower APR card if you do run into trouble.
Verdict: Scary, but escapable. High interest rates are a cause for caution for any credit card holder, but perhaps no form of debt has higher levels of awareness or flexibility.
Auto Debt ($1.24 trillion)
Auto loans have an important consumer purpose—getting people cars—and roots that are downright egalitarian.
In 1919, General Motors realized their cars were unaffordable to the masses, so they decided to loan customers cash to buy them—provided the buyer could come up with a 35 percent down payment. With that, a modern business was born: the auto finance industry.
Not to be confused with auto retail (car dealers) or auto manufacturing (car makers), auto financiers have turned the car loan into much more than a consumer tool; it’s literally one of the most successful corporate products of all time, with auto-related debt having grown from roughly $36 billion in 1970 to its current level of roughly $1.24 trillion.
And while auto loans have been hugely profitable for lenders, they also contain some of the worst attributes of all the above forms of debt. Like credit cards, auto debt harshly punishes those with less-than-stellar credit. It’s almost as massive as student loan debt. And while lenders might position auto debt as an equity investment—like a home loan—they can’t escape one key difference: A car will lose almost all of its value while you own it.
Obviously, buying a depreciating asset is an objectively horrible idea. You wouldn’t buy a stock that goes down or a piece of art that you know will be essentially worthless in five years. So why would you dedicate a good chunk of your available credit to a car? Not only is it a bad financial decision, but it also ties you to an increasingly outdated product you’ll be forced to repair, maintain and drive long after you’ve likely grown tired of it.
But that’s only the beginning of the bad bargain of financing a car. If you’re one of the roughly 43 percent of Americans with a credit score of 690 or below, your average interest rate is likely to be anywhere from 7 percent near the top of the group—all the way to 15 percent and above for those with poor credit. And unlike credit card interest, these rates can’t be lowered by transferring your debt to a lower-APR card or avoided by simply paying off your balance each month. Interest on an auto loan can’t be deferred as it is with a student loan, nor is it tax deductible like interest on a home loan. Someone with a car loan pays interest through the entire life of the loan with as much wiggle room as the back seat of a Mini Cooper.
The auto finance industry has tried to disguise this system by lengthening the term over which you have to pay back the loan—but this only subjects the customer to the terms of the loan for a longer period of time. In fact, the average loan term for a new car in America hit a record average of 69 months by the end of 2017, according to Experian, with terms on used-car loans clocking in at just over 64 months. And this tactic isn’t even helping to lower Americans’ car payments, which just hit a record of $523 for new cars in the first quarter of 2018. Clearly this situation is not working for the consumer, as 6.3 million Americans are 90 or more days behind on their car loans and at immediate risk of repossession.
Interest Rate: Medium to Very High (from around 4% for those with good credit to 15% and more for subprime loans)
Delinquency Rate: 5.8% for subprime loans (Highest since 1996)
Verdict: Under the radar and on the rise. From its inflexible terms, massive scale and baked-in depreciation, auto debt is clearly deserving of the same level of scrutiny attached to other major forms of debt—if not more.