The nation's big automakers lately have showered shoppers with fantastic
deals: zero interest, zero down, "cash back" discounts, and
more. Interest rates on new car loans hover at around 6 percent. Buying
a car has never been cheaper or easier for America's middle class.
But for lower-income customers, car shopping is fraught with high costs,
hidden expenses, and sometime less-than-honest dealers.
Many working poor Americans pay a much higher relative price for basic
transportation than their middle-class counterparts do -- with dire
consequences for their economic health and physical mobility.
High-cost transportation means less money for daily necessities and unexpected
financial shocks. For some families, higher costs make cars completely
unaffordable, and they are then trapped with limited access to employment
or affordable housing.
Having a car can also mean the difference between staying in poverty
and leaving welfare. Studies indicate that welfare recipients with cars
are much more likely to work and to make more money.
To help erase this "car-ownership gap," Congress should try
to eliminate the artificial barriers erected by the auto-lending industry
against low-income borrowers. The auto market that low-income shoppers
face today is one of few choices and high prices. But through judicious
intervention, Congress can promote a more competitive market that will
help equalize all families' access to affordable cars.
The price of subprime lending. In Northeast Washington, D.C.,
a dingy strip of Bladensburg Road is lined with car dealerships that cater
to the poor. Hand-lettered signs offer low prices and "easy credit."
But what these dealers are actually selling is expensive credit at interest
rates that are triple what mainstream buyers pay, with down payment requirements
as high as half the purchase price. Some dealers also persuade their customers
to buy and finance needless and expensive products, like credit life insurance,
which pays off a debt if the borrower dies, at the same high rates.
These dealers are part of a loose and fragmented substratum of specialized
auto finance companies -- so-called "subprime" lenders. They
target buyers with low incomes or poor credit, such as low-wage workers,
recent immigrants, or former welfare recipients. Some subprime lenders
are affiliated with large, publicly traded finance companies; others offer
"in-house" financing, using their own capital.
Many poor families have no choice but to use these corner-lot dealers.
In fact, as interviews with dozens of Washington-area dealers confirm,
working poor families are virtually shut out of the mainstream auto finance
market. Generally speaking, full-time minimum wage workers would not meet
most dealers' income requirements for prime-rate financing.
While new-car buyers are borrowing at around 6 percent, interest rates
on subprime car loans average between 15 percent and 19 percent, sometimes
higher. The interest rate on pools of loans issued by Consumer Portfolio
Services Inc. during the past four years averaged slightly above 20 percent.
For a four-year loan with an initial principal balance of $10,000, the
difference between 6 percent and 17 percent interest translates into monthly
payments of about $235 versus $289-a significant amount of grocery money.
Over the life of a four-year loan, the extra interest totals nearly $2,600.
The large down payment required by many subprime lenders also means less
car for more money. At 5 percent down, a prime-rate borrower gets a $10,000
car for $500 cash. But for a poor borrower who must put half down, $500
will buy only a $1,000 lemon. Low-income buyers also must spend a long
time accruing large amounts of cash that could otherwise be used for daily
necessities.
High payments also have the perverse effect of trapping borrowers in
the subprime market. For families living from paycheck to paycheck, small
financial setbacks -- such as an illness costing several days' pay -- could
easily cause a default. Thus, some families may never establish the good
credit necessary to move up the ladder into prime-rate financing.
Rates vs. risks. Subprime lenders argue that their rates are merely
a function of their risks, since lower-income borrowers are somewhat more
likely to default on their obligations and have fewer assets to serve
as collateral. Yet the profits from these high-risk loans are impressively
high, and the industry has grown impressively large. Ugly Duckling Corp.,
for example, reports that its average gross margin per sale in fiscal
2001 was $3,906, or 42.9 percent of the average sale price.
Household Finance Corp., one of the nation's largest subprime financiers,
serviced nearly $6.4 billion in auto loan receivables in fiscal year 2001,
more than double the amount serviced only two years before.
Delinquency rates as reported by public subprime companies are also lower
than one might expect. At Household, delinquency ratios in 2001 varied
between 1.77 and 2.89 percent -- comparable to the 2.4 percent delinquency
rates at the prime-rate General Motors Acceptance Corp.
The evidence points to one conclusion: that subprime companies charge
credit-card rates for car loans not because they have to, but because
they can.
Making cars more affordable. Congress can make cars more affordable
for low-income borrowers by increasing competition in the industry and
thereby helping to lower prices. Encouraging mainstream companies to enter
the subprime market would mean more players, more choices, lower prices,
and better industry information about the real risks of lending to the
poor -- rather than the imagined ones.
For starters, Congress should create disclosure requirements that would
help bring to light the industry's current treatment of lower-income borrowers
and uncover any abuses. Unlike the home mortgage industry, the auto industry
is a black box with very little national data available on its practices,
especially toward low-income and minority borrowers. More information
on the borrowing habits of lower-income customers might also encourage
mainstream companies to re-evaluate their attitudes toward the low-income
market.
Government should also address the other half of this equation by using
every available avenue for promoting financial literacy, so that car buyers
can avoid outright scams and make wiser choices. Free credit counseling
should be widely available and included in welfare-to-work programs.
High-cost financing perpetuates the transportation gap between low-income
families and the middle class, which in turn results in a persistent lack
of opportunities for the poor. Policymakers should make the mobility of
low-income workers -- both physical and economic -- a priority.
