If you bought a car during the recession, having bad credit wasn’t a big problem. And if you faithfully made your monthly payments, you actually got a big bonus: Your credit score went up.
Why would lenders trust “subprime borrowers” — those with credit scores under 640 — when they’re more likely to be at risk of defaulting? During the depths of the recession, there weren’t enough car buyers with good credit scores to go around.
Much like the housing bubble that sparked the recession, an auto bubble might work the same way — depending on who you talk to.
Why the auto bubble is a myth
LendingTree, an agency that helps consumers compare loans online, says that the so-called “auto bubble” is “unlikely.” Here’s why…
1. Subprime borrowers aren’t always risky.
Equifax, one of the credit reporting agencies, analyzed three years’ worth of subprime auto lending data, where it monitored those with credit scores lower than 640 who took out auto loans. The findings? The median credit score of subprime lenders increased 52 points. Equifax says that those who took out a subprime auto loan were four times more likely to increase their credit score to above 640, officially moving them out of the subprime segment.
2. Comparing auto loans to mortgages is like comparing “apples and oranges.”
What do you do if you can’t afford your house anymore? You sell it — hopefully for a profit. But you wouldn’t do the same for a car loan you couldn’t afford anymore.
One of the main differences between a mortgage and a car payment, Equifax says, is that people realize cars are depreciating assets that they don’t plan to resell for more than they paid. A house, on the other hand, is an asset that many people buy with the intent to sell at a later time for more money. Prevailing logic says you wouldn’t be as motivated to take a car loan you knew you couldn’t pay off.
3. Prime lending is growing at “more than double the speed” of subprime lending.
Unlike the “wildfire growth of the housing market” from 2004 to 2008, subprime auto loans have grown at a “controlled, steady pace,” according to Equifax. Usually when prices skyrocket quickly above their true value, that’s a warning sign that prices could tumble into freefall.
Said Equifax Chief Economist Dennis Carlson:
“We can confidently say that subprime auto lending is currently performing well, it’s not growing as quickly as prime lending, and our data does not suggest that a bubble is forming.”
Why the auto bubble is real
Equifax is making a big deal about subprime borrowers increasing their credit scores, which they say means those borrowers aren’t as risky as they appear to the lending industry. But what if it’s not just subprime borrowers whose scores have improved? What if everyone’s score has gone up?
Here are possible reasons that could be the case…
1. Credit scores of average Americans began rising after the recession.
According to Credit.com, the FICO scores of average Americans hit historic lows of 686 in 2009. Four years later, it was up four points, to 690. It may not seem like a huge increase, but what is significant is that since the first year since the recession, the average credit score is no longer declining.That means that during the years Experian conducted the study, the average Americans’ credit scores were going up, and not just for subprime borrowers.
“It was a very dismal economic era there for a while and people had no confidence,” Rod Griffin, Experian’s Director of Public Education, told Credit.com in January. “I think improving scores tells us that people are much more confident in their economic situation.”
2. Negative charges are beginning to “age off” credit reports.
It’s been approximately seven years since the recession began in 2008, and that’s great news for consumers with negative information on their credit reports.
The magic of number 7 applies to all the following types of information on your credit report:
- Late payments
- Bankruptcies (Chapter 13)
- Medical debt
If you had any of these items on your credit score, it probably hurt your score — a lot. But as time passes the negative information fades and your score improves.
If you are trying to get an auto loan, make sure you improve your credit score first.
If you’re trying to build your credit before making a major purchase like a car, try to…
1. Make all your credit card payments on time. Credit history is the biggest factor taken into consideration when calculating your credit score.
2. Keep your credit utilization low. Using too much of your available credit will cause your credit utilization ratio to go up, which also raises your score.
3. Make sure any penalties get removed on time. This means closely monitoring your credit report, which you can get for free once a year from annualcreditreport.com.