# Shopping for a New Car? Use the 20/4/10 Rule

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Imagine you’re in the market for a new vehicle. Where do you begin your car-buying process? Do you already have a dream make and model in mind? What’s your budget? Are you already browsing the interwebs for the car you want? If you are, you’re already starting off on the wrong foot — at least according to the 20/4/10 rule.

## What is the 20/4/10 rule?

The 20/4/10 rule helps car shoppers figure out how much car they can actually fit into their budget before falling in love with a vehicle they can’t afford. It emphasizes calculating what you can afford before you set out shopping.

The rule might seem obvious — before you buy something, you should make sure you can afford it, right? — but it gets tricky when it comes to financing, and many don’t take the time to include annual ownership costs. If you don’t, you could end up with monthly transportation costs that could force you to live paycheck to paycheck or take on more debt.

Follow the 20/4/10 rule, and you might avoid accidentally biting off more than you can chew.

### Rule #1: Put down at least 20%

A vehicle is a depreciating asset. The experts at Carfax estimate a new car loses 10% of its value the moment you drive off the lot. And the depreciation continues from there. Edmunds.com estimates a new vehicle loses over one-fourth of its value in the first year alone. For that reason, you should be prepared to put down at least 20% of the purchase price. If you do this, you’ll finance payments for the vehicle’s actual estimated value when you leave the lot instead of the full purchase price, which the vehicle isn’t worth anymore.

Take this example: You finance a new car for its full purchase price of \$34,000, then lose your job the next day. Now, you might need to sell your new car, but you can sell it for only \$30,600 — because the car already lost 10% of its value once it left the lot. Since you put \$0 down at financing, you’ll still owe \$34,000 after the sale. On the other hand, if you’d put down at least \$6,800, you could sell the car that day for its estimated value and only lose out on half your down payment.

You might not be able to estimate exactly how much car you can afford, but if you are able to put down at least 20% of the purchase price, you should be in an OK financial position. On top of that, you’ll have smaller payments and possibly finance it for a shorter period.

### Rule #2: Finance the vehicle for no more than four years

The longer your financing agreement is, the more you’ll pay in interest over time. So don’t be swayed by dealers or lenders who try to sell you on a lower monthly car payment — chances are your payment is so low because the term of your loan is long.

You can use the MagnifyMoney loan calculator to see this rule at work. If you borrow \$25,000 to purchase a car (at a 4% APR) and agree to a six-year financing deal, you’ll wind up paying \$3,161 in additional interest charges by the time you pay off the loan.

If you agree to a four-year loan instead, you’ll pay just \$2,095 in interest — a savings of over \$1,000. Of course, that shorter term loan also comes with a higher monthly payment — \$564 versus \$391 — but you are saving more over the long term.

Think of it this way: If you can’t afford the monthly payment required to pay off the car in four years or fewer, it’s probably outside of your budget.

### Rule #3: Keep your total transportation costs under 10% of your monthly income

This last part is where it gets easy to overspend. You should try to keep your total transportation costs — your car payment, insurance, gas, and maintenance — under 10% of your monthly income.

So, if you earn \$5,000 per month, your total transportation costs shouldn’t cost more than \$500.

## How to save on the cost of a new car

Try these tips to keep your overall transportation costs low.

### Get pre-approved for financing

Avoid financing your vehicle through the dealer, and get pre-approved for financing at a lower rate before you show up at a dealership. Financing your auto loan at a lower rate can reduce your monthly loan payment. If you walk onto the lot with a pre-approved auto loan rate from a bank or credit union, you can use that as leverage for negotiation.

However, if you let the dealer find the loan for you instead, you’ll lose negotiating power, and there won’t be a way for you to tell if the dealer’s loan rate is the best offer you can get. Avoid making these other common mistakes when searching for a car loan.

More people are purchasing used cars than ever before and saving a bundle in the process, according to Edmunds. Over 38 million vehicles sold in 2015 were used, a year-over-year increase of 5.6%.

When you buy used or certified pre-owned vehicles, you avoid financing a larger balance, and could even skip financing altogether if you’ve got enough cash on hand. If you buy used, avoid engine trouble by having the vehicle inspected by an independent mechanic before you sign off. You can use a resource like Car Talk to find a mechanic in your area.

### Buy a car that holds its value

Depreciation is a car owner's largest transportation expense during the first five years of ownership, more than fuel, maintenance, and even insurance.

A car that holds value well will depreciate less over time compared to the average vehicle, so you may not lose out on as much in depreciation costs if you sell the vehicle after a few years. Carmakers like Honda and Porsche are known for building vehicles that hold their value well over time according to Kelley Blue Book.

Leasing a car will usually result in a lower monthly payment, and you’ll likely save money with a lower down payment and lower tax fees over time. However, you could be subject to extra charges if you ding up the vehicle, or drive more miles than stated on the lease agreement. It doesn’t always work for everyone, so consider your personal needs first.

On the plus side, you’ll upgrade to a new vehicle every few years and won’t need to deal with the hassle of selling a car.

### Look for gas savings

Gas isn’t always an unavoidable expense. You can make a few changes to your fueling habits like filling up before you hit “E” or signing up for a gas rewards credit card to save money. You could also cut down transportation costs by cutting back how often you drive or by carpooling some days to school or work. Learn more ways to reduce your gas spend here.

### Comparison shop

Don’t get lazy with must-haves like maintenance and insurance for your vehicle. Comparison shopping is the best way to save on costs like these that may differ from provider to provider. Insurance companies have made it easier to compare quotes with online comparison portals like this one from Progressive. You could also try going through your bank or credit union for discounted rates with select companies.

Don’t just take the first estimate you get for a repair. Mechanics are known to pad the bill with unnecessary repairs from time to time. After you figure out what’s wrong with you vehicle, get an estimate from a few different mechanics in your area. That way you’ll make sure you’re getting the best value before paying for maintenance and repairs.

Advertiser Disclosure: The card offers that appear on this site are from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all card companies or all card offers available in the marketplace.

Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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# In Auto Lending, Dealer Discounts Are Dangerous And Potentially Predatory

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

This week, the Wall Street Journal reported that the Consumer Financial Protection Bureau's crackdown on racial bias in auto lending could result in higher prices for many borrowers. Over the last few years, the CFPB has aggressively fined large auto lenders for charging higher interest rates to minority borrowers. In 2013, Ally Financial was ordered to pay \$80 million in damages to harmed African-American, Hispanic, Asian and Pacific Islander borrowers. In addition, Ally also had to pay \$18 million in penalties.

Although the CFPB does not have oversight of auto dealerships, it does have oversight of indirect auto lenders like Ally. Typically, auto dealerships will sign deals with multiple auto lenders. The lender will set a risk-based interest rate, called the "buy rate." The interest rate charged to the customer can never be lower than the buy rate. Higher risk borrowers with lower credit scores would be charged a higher buy rate. For example, a lender may set a 4% buy rate for someone with a 750 FICO, and an 8% buy rate for someone with a 650 FICO score.

In addition to the buy rate, there is a "dealer markup." Dealers try to get as much as they can, and for good reason. Historically, dealers have been allowed to add up to 2.5% to the buy rate and they are able to keep a big portion of that extra interest as revenue. So, the higher the interest rate charged by the dealer, the more money that the dealership will make on the loan. Auto dealerships make most of their money from financing and warranties, not from the sale of automobiles. And the dealer markup is a disproportionately large contributor to the dealership's earnings. That is why MagnifyMoney always recommends that borrowers shop around for an auto loan interest rate before walking onto a car lot. Dealers have a lot of room to negotiate, and can often beat the rate that you find online before you shop for your car. But if you do not come prepared with good financing already in hand, dealerships will do their best to charge the highest interest rate possible.

Many savvy auto shoppers understand how the game works. As a result, they are ready to negotiate hard with auto dealers. People who negotiate at dealerships tend to get much lower interest rates. People who don't feel confident negotiating often end up paying more.

The CFPB performed an analysis of the borrowers, and determined that minority borrowers paid higher interest rates than white borrowers. The difference ranged between 0.2% and 0.3%. The statistical analysis has been widely disputed by lenders, dealerships and the Wall Street Journal. Car lenders complained because the CFPB was fining them for the activities of auto dealers.

In response to the CFPB actions, auto lenders have responded by eliminating or dramatically reducing the dealer markup. To make up for lost revenue, the buy rate has been increased. Before, good negotiators could get better rates than bad negotiators. Now, that ability to get a lower interest rate has been largely removed. Some borrowers will see higher interest rates, and some will see lower interest rates.

### Fixing Interest Rates Is Not A Bad Thing

Economists generally believe that bartering is not an efficient way to manage supply and demand. Although tourists often enjoy bartering when on vacation, most people are happy that prices are fixed in grocery stores. Imagine if every item in a grocery store had a base price, and then a mark-up on top. When you take your items to the cashier, you are forced to negotiate on every item's price. In this system, pricing goes down for those who are most willing or able to negotiate. But prices overall remain higher than they should. With fixed costs and transparent pricing, supermarkets are forced to compete systematically.

Unfortunately, auto financing has remained largely on the inefficient barter system. Rather than a national competition between lenders fighting to offer the lowest interest rates for people with certain FICO scores, the negotiating takes place behind closed doors in the back of auto dealerships.

Whenever you empower an employee to negotiate price, there are unintended consequences. Early in my banking career, banks would often allow branch employees to set the interest rate of loans. Here are some examples of the type of abuse that can happen:

• A racist branch manager gives African American borrowers rates that are 2.5% higher than interest rates charged to white individuals.
• An aggressive sales agent wants a big commission, and gets aggressive with the most vulnerable. Customers who had the least education, the lowest level of financial literacy or the least self-confidence would be charged higher interest rates.
• A young, recent college graduate is enjoying his new pricing power. Whenever a young, beautiful woman comes into the office, he reduces the interest rate.

When I worked in banking, we regularly eliminated the ability of front-line sales agents to charge higher prices. But why has the barter system survived in auto lending?

### Why Did This Happen In Auto Lending?

Why were auto lenders willing to give so much power to dealerships? Unlike credit cards, which banks can sell online or in branches, auto loans are usually sold in dealerships. The dealers are not controlled by the finance companies or banks. And the dealers want to make the banks compete. Banks would give auto dealerships big dealer markups to buy loyalty. Auto dealerships would be told that they could keep what they were able to charge. Banks would compete on the lowest buy rates and the highest markups.

A bargain-based system is inefficient, painful and particularly punitive for people who are least likely to bargain. At MagnifyMoney, we support transparent, public and painless pricing structures. Although we agree with the Wall Street Journal analysis that pricing will increase for many borrowers, we do not think that is necessarily a bad thing.

Competition should be systematic. A 750 FICO borrower should be able to shop for the best interest rate without having to fear a painful negotiation in the back room of an auto dealership. Lenders will still have to compete. However, going forward, anyone with a good risk profile will benefit from market competition, rather than side-deals for those who are the best at negotiating.

Advertiser Disclosure: The card offers that appear on this site are from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all card companies or all card offers available in the marketplace.

Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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# Americans Are Going Deeper Into Debt As Banks Relax Lending Criteria

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Today, Experian Decision Analytics released its report on consumer credit trends in the United States during the second quarter of 2015. The data shows a clear trend: Americans are borrowing more, and banks are relaxing credit criteria once again.

New credit lines issued by banks on credit cards have reached a post-crisis high. Auto loan originations have grown 16% over the last 12 months, and total auto balances have crossed the symbolic \$1 trillion mark. Mortgage originations are up 50% since the trough of Q1 2014, and home equity originations are up more than 60% since 2014.  Growth is coming from familiar products, familiar FICO score and familiar states. Not surprisingly, states like Florida and California are leading the growth of home equity withdrawal, and near-prime is once again popular marketing territory.

Banks and credit unions are increasingly willing to offer credit to riskier borrowers. Credit card issuance to near-prime customers is up 7%. Non-prime auto loans are growing by more than 15%. After the credit crisis of 2008, banks had tightened credit significantly. Over the last 12 months, banks have started to grow aggressively in the near prime sector (borrowers with credit score of 601 - 660). In the last credit crisis, some of the worst credit loss performance came from near-prime borrowers. A huge bet is being made on consumers having "learned lessons," from the previous crisis. Banks are willing to lend on the presumption that borrowers are more responsible now.

At the moment, delinquency and losses still look low and stable. But delinquency and losses should look good at this point in the credit cycle, because losses lag loan growth. Default performance today comes from the loans and credit limits that were issued in the past. As banks continue to offer credit to higher risk borrowers, it will take a few years before the true impact of the increased risk tolerance will be known. One thing is certain: delinquency and losses will definitely increase over time from current levels.

A lot has been written about the growth of marketplace lenders. Although marketplace lenders have been making a lot of noise, traditional banks continue to grow rapidly. And credit unions have quietly been growing their assets at an astonishing rate. In some respects, the credit unions are the opposite of marketplace lenders. They are light on technology and data. Yet they are rapidly increasing their exposure to the sub-prime auto sector. Many large banks have shrunk, because they are unable to compete on price.

Below are some of the key highlights from each segment.

### Credit Cards

The data from Experian tracks credit cards issued by banks, and shows the dramatic and rapid growth experience during the second quarter.

• \$83 billion of new bankcard credit lines were issued, a post-crisis high.
• 87% of the new credit lines were granted to prime and super-prime customers. But the accelerated growth is coming from near-prime.
• There was a 7% growth in credit limits issued to customers with near-prime scores. A total of \$8.2 billion was issued during the quarter.
• Credit card balance growth is starting to accelerate. Balance growth always lags limit growth, but there was a 3% growth rate in balance during the quarter and looks set to accelerate.
• Credit card losses remain around 4%, and delinquencies remain at low levels.

### Auto Loans

Auto loan growth continues at a rapid pace, and a lot of the lending is happening with lower risk borrowers from nonbank lenders and credit unions.

• \$160 billion of new loans were granted in the quarter, a 16% increase over the prior quarter.
• \$577 billion of loans have been issued in the last 12 months, up 10% compared to the previous rolling 12 months.
• Subprime auto loans expanded 14.8%.
• Near-prime volume is also up 15.3%.
• 56% of all auto loan originations are from non-prime consumers.
• Credit unions are now responsible for 25% of all originations, and finance companies are responsible for 18%. Traditional banks are losing market share to finance companies and credit unions.
• At credit unions, 34% of originations are to borrowers with credit scores that make them either near-prime or sub-prime. This raises concerns about the amount of risk that credit unions are taking in a high risk segment of the market.
• Auto loans have crossed the \$1 trillion balance mark, an increase of more than 10% compared to last year. Since 2012, auto loans have increased a staggering 43%.

### Mortgage Loans

Since Q1 2014, mortgage volume has started to accelerate rapidly. Fear of an interest rate increase has inspired a lot of refinance activity now, while rates are low. And the purchase market continues to heat up, as more people decide to purchase homes.

• Mortgage originations have increased 50% since the trough of Q1 2014.
• Nearly \$1 trillion of new mortgages have been originated so far this year.
• Purchase mortgages are now at 57% of total mortgage volume.
• California, Texas and Florida continue to dominate the market.
• The fastest growth in coming from Hawaii, South Dakota and Washington.

In addition to first mortgages, the Home Equity Line of Credit (HELOC) business is accelerating. \$42 billion of HELOC were originated during the quarter, an increase of 23.5%. Equity withdrawal continues to remain most popular in states like California and Florida.

### Implications

Anyone who has been in banking for a long time understands that credit is cyclical. Right now, we are clearly in an expansionary phase of the credit cycle. Borrowers who were once toxic look good again. Top line growth is accelerating. Coincidental delinquency and losses look good. And we all convince ourselves that we have learned out lessons from the past cycle.

One thing is clear: at some point delinquency and losses will increase. The quality of the underwriting today will determine the extent of the deterioration in the future. Credit card businesses should be least at risk, because of their high interest rates and ability to mange the credit limits. Subprime auto loans underwritten by credit unions, with limited experience and low interest rates, pose a much greater risk. But only time, and more data, will reveal the wisdom of decisions made by both banks and borrowers.

Advertiser Disclosure: The card offers that appear on this site are from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all card companies or all card offers available in the marketplace.

Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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# FDIC Allows Ally Bank To Make 620 FICO Auto Loans

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

During Ally Financial's earnings announcement today (transcript here), CFO Chris Halmy revealed that the FDIC has given permission for the bank to start using FDIC insured deposits for auto loans with credit scores as low as 620. Previously, Ally could only use deposits for loans to borrowers with 650 or higher credit scores. With this change, nearly 75% of Ally's lending portfolio can now be funded with deposits. According to Halmy, "we are focused on eventually getting everything funded at the bank."

### Why Did The FDIC Have Restrictions On Ally?

Ally Bank was created as a result of General Motors' near collapse and government bailout during the 2008 crisis. GMAC, the auto lending division of General Motors, was spun out as a separate company, capitalized by the government and renamed Ally Bank.

The regulators wanted to make sure that no further taxpayer money would be required to bail out General Motors or Ally. So they put big restrictions on how FDIC-insured deposits, raised by Ally Bank, could be used. The biggest restriction was the minimum credit score for all borrowers. Ally Bank is famous for simple, high interest rate savings accounts available online. Ally savings accounts currently pay 0.99%, compared to the average 0.01% at large, traditional banks. While that interest rate might sound high for savers, it is a very cheap way to raise funds for a bank like Ally.

Ally Bank had to find funding for its large auto loan business. For borrowers with high credit scores, the bank could use its deposits, which cost less than 1%. But for borrowers with low credit scores, it had to raise money from the debt capital markets. Debt investors required high interest rates to fund subprime auto loans. While Ally could receive interest rates below 1% from consumers, it had to pay above 4% to the debt investors. Ally is clearly motivated to reduce debt funding, and increase deposit funding.

The FDIC did not want to Ally to use its low-cost deposits to fund higher risk auto loans. However, as the market improved and the new management team of Ally gained the trust of the FDIC regulators, the restrictions have been relaxed.

### What Does This Mean For Consumers?

Ally has a simple business model. The bank looks to raise deposits online and make auto loans. Ally has made good progress building a profitable business with better risk management. In the last three months, Ally generated core earnings of \$435 million.

Ally Bank will now be able to reduce its funding costs for consumers with FICO scores between 620-650. The reduction in funding costs can have three potential outcomes:

• Ally reduces its headline interest rate, passing savings along to consumers. The lower rates make the product more competitive, and enables Ally to grow faster.
• Ally expands it credit underwriting policy, approving more borrowers in that score range. Because there is a lower funding cost, Ally has the ability to take more risk.
• Ally makes more money, booking the funding savings as profit.

Based upon indications from management, the focus will be on generating more earnings for Ally, rather than reducing interest rates for consumers or expanding the risk acceptance criteria. However, over time, Ally may use its funding advantage in subprime auto lending to expand market share.

For depositors who enjoy Ally's high interest rates, this is good news. Now that Ally has more places to use its deposits, it will want more of them. Expect the good interest rates to continue.

### Should Taxpayers Be Worried?

Ally Bank is a different organization from GMAC. The annualized credit loss rate in Q2 2015 was only 0.39%. This low loss rate is the result of dramatic changes and improvements to the risk management infrastructure and policies. The biggest change is that Ally is no longer a division of an auto lending company whose sole purpose is to help drive auto sales. Instead, Ally is stand-alone bank with an experienced risk management team, who are paid based upon the long-term performance of the bank. In addition, Ally remains highly profitable and has a strong capital cushion. The Tier 1 ratio of Ally Bank is 11.7%.

Ally indicated that it plans on product expansion. We can expect Ally to consider other lending businesses as it finds even more uses for its highly successful deposit-gathering franchise.

### Options For Consumers

[Disclosure: LendingTree is the parent company of MagnifyMoney.]Consumers looking to finance a car, can do so directly with Ally Bank on their website. Keep in mind that it is best practice to compare your options. We recommend starting with LendingTree. They have hundreds of lenders on their platform. After you complete an application, you can see real interest rates and approval information. Note, some lenders will do a hard pull on your credit and that this is normal with auto lending. Since multiple hard pulls will only count as one pull, the best strategy is to have all your hard pulls done at one time. You can shop for rates on LendingTree's website.

Advertiser Disclosure: The card offers that appear on this site are from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all card companies or all card offers available in the marketplace.

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Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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# Wells Fargo Restricts Subprime Auto Lending

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

The subprime auto lending market has experienced dramatic growth over the last few years. In a low interest rate environment, investors have been looking for yield, and subprime auto loans have become a preferred vehicle. However, as the New York Times reported, Wells Fargo has put a cap on the amount of subprime auto loans that they are willing to originate. They have capped subprime at no more than 10% of their total originations, which was \$29.9 billion last year. Wells Fargo made itself famous during the subprime mortgage crisis, because it managed to largely escape unharmed. They are famous for avoiding the "growth-at-all-cost" strategy that brought down much of the financial world. So, when they start capping certain loan types, we should all pay attention.

The subprime auto lending market has been demonstrating signs of excess for quite a while. Auto dealers sit at the center of this market, and they control access to the customer. Their lending desks (the place where you sit, after you selected your car, and try to get financing) want to deal with lenders who approve the biggest loans, with the highest dealer discount (commission paid to the dealership) and the fewest requirements. The auto dealerships make most of their money from the commission paid by the lenders, and so they are intensely focused on maximizing that fee.

As you can see from this arrangement, there is a huge conflict of interest in this setup. The auto dealer is not looking for the best deal for the consumer.

And, as yield hungry investors and lenders look for more business, they have to compete to win the dealer's business, not the borrower. So, competition does not drive prices down. Rather, it drives up the commission paid to the dealer. It also removes, to a bare minimum, the compliance and control checks placed upon the dealer. If you owned an auto dealership, would you want to give your business to a lender that is constantly auditing your work, or would you rather deal with a lender that gives you complete control?

Inevitably, lower controls and higher commissions leads to the increased risk of falsification of income information. In addition, lenders will start approving unprofitable business, because that "marginal tranche" of business gives them access to the whole dealership business flow. This helps the auto dealer get more loans approved, but it also results in an increasing number of people signing up for loans they can not afford to repay. And that is why we are seeing delinquencies increase.

Even worse, we see the same misalignment of risk from the mortgage crisis. For most of the major subprime auto lenders, they do not retain the risk on their balance sheet. Rather, they slice and dice the business and sell it to investors. And the sale does not happen before credit rating agencies give the paper AAA ratings. How can subprime (below 640) customers end up with AAA or AA ratings? Well, the same rating agencies are using the same logic from the mortgage crisis. An individual with a 640 score is high risk. But, a portfolio of loan is low risk because of diversification.

There is also a belief that these loans are secured, and that people will pay their auto before their house. However, people are using data from 2008, which shows underwater homeowners prioritizing their car over their home. These days are over. Not to mention that dealers have an incentive to inflate the value of the used cars, making the level of security questionable.

We all know that automobiles are depreciating assets. In that, everyone agrees. So, it ultimately comes down to making sure people can pay back their loans. The increasing delinquency, and the worries of Wells Fargo, says that for many people, they can not afford the loans. We fear this problem will only get worse before it gets better.

Advertiser Disclosure: The card offers that appear on this site are from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all card companies or all card offers available in the marketplace.

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Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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# Student Loan Defaults Soar

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Today, the New York Fed released its report on household debt and credit for the fourth quarter of 2014. Credit growth continues, with total balances increasing \$117 billion, or 1.0%. All types of credit demonstrated robust growth, with the exception of home equity lines of credit. However, Experian Decision Analytics has reported separately that new home equity lines of credit are being issued at an increasing rate, so we should expect to see even this asset class start to grow over the next 12-24 months.

The delinquency rates, which measure the percentage of people not paying their balances on time, decreased in most categories. This is the result of tighter underwriting after the crisis, improved employment and economic conditions for households and wider availability of credit. However, two categories have demonstrated increases in delinquency: auto loans and student loan debt.

### Auto Loans

Much has been written recently about the growth in the subprime auto loan industry. Investors, hungry for yield, have been pouring money into the subprime auto sector, raising questions of lax underwriting standards and abusive lending practices. The Fed noted that they have seen a pronounced uptick of flows into delinquency for the subprime auto sector.

All of the ingredients of the subprime mortgage crisis can be found in the subprime auto industry. The dealerships originate and underwrite the loans. Like the mortgage brokers, their incentive is tied to the size of the loan, and they have virtually no economic concern about the quality of the loan. The decisions are largely score-driven, ignoring common sense cash flow and income considerations. The loans are packaged and securitized, with "diversified" pools of debt attaining high investment grade ratings. And, as competition heats up, underwriting standards and auditing have become more lax, because the lenders are chasing volume and want to keep the dealers happy. This is a slow-moving train wreck that has been widely written about by the New York Times, but largely ignored by the regulators.

### Student Loan Defaults

However, the highest absolute level of delinquency is with student loans. 11.3% of student loans are now 90 days or more delinquent, a shockingly high level, and a level that continues to increase. Students loans now have the highest delinquency level of any form of household debt. Because it is nearly impossible for people to eliminate student loans in bankruptcy, we are seeing the creation of an "ever-increasing pool of delinquent debt."

Even though these headline numbers are shocking, the Federal Reserve hinted that more granular data shows how the situation continues to deteriorate. They will be releasing more data as the week progresses, which will likely paint an increasingly horrific picture of the credit quality of students.

The majority of the credit risk is taken by the federal government. However, there are much bigger concerns than the cost of default for the federal government. An increasing percentage of American citizens are being tied to student loan balances that they can never hope to repay. Theses defaults never disappear and will reduce their ability to become economically active members of society. The student loan defaults will restrict their ability to purchase automobiles and homes, as well as limit their ability to plan for retirement.

Advertiser Disclosure: The card offers that appear on this site are from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all card companies or all card offers available in the marketplace.

Nick Clements |

Nick Clements is a writer at MagnifyMoney. You can email Nick at nick@magnifymoney.com

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