Car Loans

Like all sophisticates, I’ve been trained to say things like “the American car companies are really banks that make cars as loss-leaders” but I have no idea how that actually works. Indeed, since I’ve never owned a car I have only somewhat fuzzy ideas about what getting a car loan entails. But Stephanie Mencimer does a great job of detailing how the car loan business looked amidst the general credit madness:

Here’s how it works: When a customer comes into a dealership to buy a car, he already knows how much the car should cost (thanks to the Internet), but he usually relies on the dealership to arrange the financing, often because they advertise lower rates than banks. That’s when the scam starts. Many car dealers routinely load up car loans with all sorts of expensive but useless add-ons. These include such things as “theft etch,” when a dealer will spend $37 to etch the VIN number of the car onto the windshield, tout it as an “antitheft measure,” and charge the customer upward of $2,000 for it. Unbeknownst to most car buyers, dealers also routinely—and legally—bump up the interest rate offered by the bank or finance company in exchange for kickbacks from the lenders, which are often the manufacturers themselves. And in many cases, dealers encourage customers to trade in a car that isn’t worth the amount of their current loan by offering to roll the old loan into the new one, thus inflating the principal and making the loan more lucrative for the lender. That’s how people can end up owing $40,000 on a Ford Focus. This only works because auto lenders now stretch out the terms to six or seven years to make the payments affordable, a practice that virtually ensures that many cars won’t last as long as the loan. (In the 1980s, by contrast, Spinella says the average car loan lasted only three years and required a 20 percent down payment, which limited the kind of negative equity problem seen today.) [...]

The driving force behind all of these loan shenanigans is Wall Street. The automakers’ finance arms (and banks, too) have made a fortune by packaging the inflated loans made by their dealerships and selling them as securities. It’s the same scheme that ultimately brought down the subprime mortgage industry. And just like the mortgage lenders, the automakers and their finance arms must have been well aware that the loans generated by their own dealers were frequently bad ones. That’s because consumer lawyers have been successfully suing them over this for years.

I think they may revoke my “real American” card for saying this, but the whole habit of debt-financed car purchases seems like bad news to me. I can think of basically two “good” debt scenarios. One is that people and/or businesses sometimes need to take on debt in order to finance a potentially profitable undertaking of some kind. That could be starting or expanding a business, or it could be something simple like paying college tuition. Sometimes you need to spend money to make money, and sometimes you don’t have money. This is the core purpose of credit. The other is the basic non-investment case of homeownership. Since you have to live somewhere or other, there’s no alternative but to be making monthly payments to someone or other for the right to live someplace. Depending on the math, making a monthly mortgage payment to a bank could be smarter than making a monthly rent payment to a landlord.

Beyond that, you’re into “bad” debt terrain — spending money you don’t have in order to buy consumption items. Sometimes this is genuinely unavoidable due to income fluctuations. But insofar as it’s possible, the prudent person will try to avoid it. The long-term costs of carrying credit card debt are enormous and it makes a lot of pragmatic sense to avoid doing it.

Cars, even though they’re really expensive, are basically a kind of consumer good. If instead of taking out a loan to buy a car, you spend a couple of years socking away that monthly payment in some kind of reasonably safe investment and then buy the car outright when you can afford it you can save yourself a lot of money. Since everything reminds me of the desirability of smart growth and better urban planning, let me observe that smart growth and better urban planning could help a lot here. The built environment exists on a spectrum of auto-dependence, with someplace like Manhattan where it’s expensive and unnecessary to own a car at one pole. Then at the other extreme, you have places where it’s totally impossible to exist as an independent person without a car and every member of the household over the age of 16 needs a personal vehicle. Lots of places, however, exist in a kind of middle ground where either that first or second car might be desirable but is also by no means necessary. Creating more places like those would to some extent reduce the number of cars people own. But perhaps more importantly, they would give people a bit more flexibility about what they want to do and give them the opportunity to make more prudent financial decisions. If you get yourself in a situation where you need a car, then you need the car whether or not you have the money for it, and whether or not taking out a car loan is going to be serious trouble for your long-term finances. But if you just live someplace where a car is desirable you have the chance to delay purchasing for a while as you save up and in the long run that can leave you in much better shape — and with a car.