There has been a sudden rise in early car loan payment defaults. These are car loan defaults that happen within the first six months of the origination of the loan. Virtually all lenders agree that the root cause of this is loan fraud, by the dealer or buyer. Numbers and/or personal information are not verified by lending institutions until the defaults begin. But lenders are in a great position to make money whether the buyers pay down their loans or default. 

How do car dealers and lenders make money on defaults?

Around 10% of car dealers commit loan fraud, with almost 70% of defaults being from fake pay stubs and synthetic personal information. But lenders play a big part. Credit Acceptance and Santander Consumer USA were found by two state attorneys general of law violations over their lending practices. 

Accusations of accepting loans they know will fail and also of putting borrowers at precarious financial risk. Attorneys general in Mississippi and Massachusetts allege these lenders “squeeze as much money from delinquent borrowers as possible,” according to Consumer Reports. In each state’s case against the lenders, they ultimately settled in court without admitting any wrongdoing. 

Why do some car dealers and lenders charge so much interest?

In cases involving settlements, evidence showed lenders and dealers worked together, marking up certain cars low-income borrowers might afford. Other times they push borrowers into more expensive cars they know will require monthly payments higher than they can handle. Still, another is paying dealers less in fees for subprime borrowers. These and other ways are how a profitable outcome is a guarantee for both the dealer and lending institution. 

The typical methods lenders used are high-interest rates and long-term loans. In some cases, 84- and 96-month loans are ways to keep payments lower. If they default, lenders repossess the car, and both wages and tax refunds are garnished. And this happens with regularity in an industry where there is extensive regulation. 

With credit scores readily available, it is easy for less-ethical companies to identify subprime borrowers that are more vulnerable to high-interest, long-term loans. Subprime is a score lower than 650. The industry median interest charged for subprime car loans is 15%. Financing through a bank or credit union is around 10%.

How much can a car lender make from early loan defaults?

Offering loans to subprime borrowers poses risks for lenders. So it’s fair that higher interest rates come into the equation. But according to Massachusetts Attorney General Maura Healey, between 2013 and 2019 lenders on average made $3,100 after six months on defaulted loans in the state. 

Some lenders do try and work with people that fall behind. Modifying the terms of the loan or deferring payments are two scenarios. But some lenders manage loan collection more than actually originating loans. 

A Mississippi lawsuit revealed that Credit Acceptance employs over 50% to cover servicing and collection of loans, but only 28% to originate loans. And 35% of its loans end in repossession. According to Consumer Reports, Ford Credit, the automaker’s lending arm, reports only 1% of its loans end in repossession.