Since the collapse of the subprime mortgage market, lenders have all but stopped offering loans that sound too good to be true. But that's not the case with subprime automobile loans, which lenders continue to market aggressively to consumers with imperfect credit.
"Don't let bad credit stop you from getting a new car!" a voice actor exclaims in one television ad, as images of shiny sport utility vehicles appear onscreen. "At 450Credit.com, a 450 credit score, plus $450 a week in income, equals a brand-new car!"
Advances in technology could explain why lenders continue to offer subprime car loans. While the loans are still risky, these technologies have made the process of repossessing vehicles cheaper and easier, minimizing potential losses on soured loans.
For example, massive databases can now track the location of license plates so that lenders can quickly snatch up cars on which their owners have missed multiple payments. The past decade has also seen the proliferation of in-car devices that some lenders use to locate vehicles and lock ignitions when their customers miss payments.
Taken together, the technologies improve the chances that auto lenders will recover their collateral.
"We have the ability to find auto assets when traditional methods of finding auto assets don't work," said Chris Metaxas, the chief executive officer at of Fort Worth, Texas-based Digital Recovery Network, which uses cameras mounted in the cars of repo men around the country to take pictures of license plates on parked cars. "And that's hundreds of repossession agents simultaneously, with thousands of cameras."
The photos get matched with GPS data and fed into a searchable database. Then auto lenders can marry that data with information from other sources in order to get a rich understanding of their customers' daily habits.
Privacy advocates are raising concerns about how technology has changed the repossession industry. But there's no question that cameras have simplified the process of retrieving cars. Rather than knocking on neighbors' doors to track down delinquent borrowers, repo men can often go straight to locations where the vehicle has been seen recently.
Scott Jackson is chief executive officer of MVTRAC, a Palatine, Ill., company that maintains another database of license plates and their locations. Improved technology, he said, has sped up the recovery process to the point where fewer loans are being getting charged off.
Today, auto lenders are finding additional uses for these databases earlier in the lending process. For example, when a borrower fills out a loan application, the address he provides can be cross-checked with a license-plate database and other sources, in order to determine whether he is actually living at the address listed.
Even if lenders have reason to believe a borrower is lying, some will still make the loan, according to Jackson. That's because the lender knows where to find the car, and the borrower doesn't know that the lender knows.
And there are other technologies that are further changing the risk calculus for auto lenders.
In deep-subprime lending, which Experian defines as loans to borrowers with credit scores below 550, cars often come loaded with devices that use GPS technology to track the vehicle's movement, as well as ignition locks that can be activated remotely if the borrower misses payments.
These devices are controversial, with some drivers reporting that they've found themselves stranded in the middle of an intersection after the ignition was locked.
"When you have a subprime credit score, you might feel like this is the only option you have," said Chris Kukla, senior counsel for government affairs at the Center for Responsible Lending. "In most cases, it's a take-it-or-leave-it proposition."
But from the lender's standpoint, an ignition lock can act as a powerful motivator for a borrower to pay. The devices also make the repossession process easier.
"They reduce the number of collectors that you need, because a collector can handle more accounts," said Ken Shilson, president of the National Alliance of Buy-Here Pay-Here Dealers, a trade group representing auto dealers that extend credit directly to borrowers, often at high interest rates. "And you get an increased recovery rate because you find the vehicle quicker."
Still, it's not clear whether these improvements in lenders' ability to recover their collateral will be enough to compensate for an increase in risky auto lending.
Subprime auto lending hit at an eight-year high in the first four months of 2014, Equifax said last week. And according to Experian, auto loans to deep-subprime borrowers rose by 51% in the first quarter when compared to a year earlier. In a reprise of the subprime mortgage boom, much of the lending is being driven by strong demand from secondary-market investors.
Among banks, 4% of auto loans made in the first quarter were classified as deep-subprime, and another 14% were subprime, according to Experian. Those percentages were far higher among buy-here pay-here dealers and auto finance companies.
There are some recent signs of deterioration in the performance of subprime auto loans, but industry analysts say there's no reason to panic.
According to Standard & Poor's, the percentage of subprime auto loans that lenders recover after borrowers default fell to 48.7% in the first quarter, down nearly five percentage points from a year earlier, though the recovery rate was still well above its recession-era low.
"Yes, losses are rising, but from record-low levels," Amy Martin, senior director of S&P's asset-backed securities group, said last week during a conference call.
Factors that may be counteracting the improvements in the tracking of collateral include longer loan terms and smaller down payments.
What's more, vehicles are losing their value at a faster rate than they were a few years ago, according to a report released last week by Black Book and Fitch Ratings. The report projected that depreciation rates will rise to 13.5% this year and 15% next year.
Higher depreciation rates mean bigger losses for lenders when their loans go bad.
In 2011, the depreciation rate plunged to 7.7%, as the inventory of new cars was sharply reduced during the financial crisis, but pre-recession rates ranged from 15% to 18%, according to the report.
"It's still a good market. It's not a market that's been as good as we've had the last few years," said Ricky Beggs, senior vice president at Black Book.
He said that the post-recession boost in new car manufacturing and the large number of leased cars that are expected to be resold in the next few years will continue to put downward pressure on used car prices.