Figuring out the interest rate on auto loans is a blurry process that may take factors other than the applicant’s creditworthiness into question and will likely lead to a spike in delinquency and default rates in the coming years as forbearance and deferment programs put in place for the COVID-19 pandemic expire, according to a study published by Consumer Reports.
The study attempted to determine how auto loan interest rates were established by looking at various characteristics of the individuals who obtained the loans, such as monthly income and credit score, but Consumer Reports concluded that other factors — like dealerships and lenders setting interest rates base on “what they think they can get away with” and discrimination — may be playing a large role in those calculations that are taking place away from the consumer’s eyes.
Consumer Reports created a database of nearly 1 million auto loans to try and build a model to help identify the process through which interest rates were determined. Interest rates can play a large role in determining how much an individual ultimately pays when buying a car. Two borrowers who purchased the exact same vehicle with roughly the same underlying financial situation were given widely different interest rates — one was 4.9% and the other was 14.1%. The individual with the 14.1% loan will pay $7,000 more over the life of the loan than the individual with the 4.9% rate.
Higher payments also leads to more delinquencies and defaults. About 20% of the loans in the database created and analyzed by Consumer Reports were delinquent. That number is expected to increase in the coming months, according to the report, as pandemic-related deferment programs are wound down.
About 25% of the individuals in the Consumer Reports‘s database were spending more than 10% of their monthly income on their car loans, which credit experts say is too much to dedicate to that one area of their lives. A payment-to-income ratio above 14% leads to a 50% higher default rate, according to one industry expert.