Should subprime auto loans be avoided when rebuilding credit?

For individuals struggling with debt management or poor credit, a subprime auto loan may seem like a solution. Make sure you are informed of the risks.

A number of life circumstances might necessitate a bankruptcy. For example, an unanticipated illness or accident might result in overwhelming medical bills. Corporate downsizing might result in a period of unemployment or reduced wages. In the context of the housing market, individuals who took out an adjustable rate mortgage before the housing crash may have found themselves facing very unfavorable options at the end of the ARM’s fixed-rate period, due to depressed housing values. Similarly, homebuyers who took out a subprime mortgage may have ultimately found the higher-than-conventional interest rates unsustainable.

In fact, any number of circumstances might result in a reduced cash flow. Unfortunately, the paradox of tough times is that efforts to make ends meet sometimes only result in greater debts. This outcome is often seen with credit card spending, where high interest rates may snowball debt to a point that a borrower can no longer meet the minimum payments. At that point, a bankruptcy attorney may be the best resource for determining a course of action.

Subprime lending in the used car market

A lesser known -- but equally serious -- debt management struggle can be seen in the case of subprime auto loans. According to recent data, used-car dealers across America may be granting auto loans to individuals whose credit history would otherwise make them ineligible. As with subprime mortgages, the subprime auto loans may include unfavorable terms, such as higher interest rates or harsh consequences in the event of a late or missed payment. Some subprime auto loan interest rates may even be above 23 percent, resulting in a loan obligation that may exceed the used car’s value twice over or more.

To put this trend in perspective, nearly one-quarter of the country’s auto loans in 2013 went to individuals with credit scores of 640 or lower, according to Equifax data. By industry standards, a credit score at the level is considered subprime. Unfortunately, the parallels to the subprime mortgage crisis don’t end there. Some subprime auto loans are also being bundled into bonds and sold as securities. Wall Street investors, public pension funds, insurance companies, mutual funds and other buyers seem to be creating a growing demand for those loans. The only saving grace may be that the subprime auto loan market is only a fraction of the size of the former subprime mortgage market. Unfortunately, it is growing.

Ways to rebuild a subprime credit score

Perhaps most troubling is that many of the subprime auto loan documents may contain incorrect information about the borrowers. In one example, a loan listed a borrower’s former job as his current income source. In other cases, loan documents may omit details such as a borrower’s receipt of federal disability benefits or unemployment status.

A bankruptcy attorney understands the importance of having good credit. For those that are struggling with debt management or considering taking out a subprime auto loan, it may be beneficial to consult with a bankruptcy attorney. An attorney can recommend debt management strategies with an eye toward rebuilding credit. For example, creating a budget, applying for a secured credit card, and sticking to a savings account plan are all strategies that may help a debtor regain control of his or her life. In some cases, a subprime auto loan may even be a viable option, provided that the monthly payments are within a debtor’s budget. An attorney can review an individual’s complete financial profile and offer sound advice.

Keywords: bankruptcy, subprime loan, debt management, poor credit, credit score, credit rating, medical debt