The Road to Auto Debt | Online Only | n+1

For many Americans, it is easier to acquire a new car than to find a rental apartment they can afford. But there is a high price, in sheer debt, to pay for getting that ride on the road. The average monthly loan payment for a new vehicle recently passed the $700 mark, a figure that does not include insurance and the steep costs of maintenance. Currently, Americans owe 1.52 trillion dollars in auto debt—a staggering sum that has doubled over the last decade, due in large part to the migration of subprime loans from the housing to the auto market.

Buyers routinely drive off the lot in cars that are beyond their means. This is especially true for the more than one in three American consumers with subprime credit scores, which a cycle of bad auto debt will only tank further. No other asset loses value so rapidly, or is financed by such loosely regulated lenders, prone to predatory practices. With loan terms now being stretched to more than 84 months, many owners never succeed in paying off their debt. They end up “upside down” on their loans, meaning that they owe more for the car than it’s worth—and so they fold the balance into another loan for a new vehicle. (In 2020, a whopping 44 percent of all traded-in vehicles were carrying negative equity.) Lenders show little leniency if they fall behind on payments. Indeed, many expect borrowers to default, and so repossession is invariably the next step, allowing dealers to sell the car to the next sap. Even if surrender of the vehicle is voluntary, drivers take a big hit on their credit scores, making that next car loan more expensive and their debt hole even deeper. Yet there is no alternative. The prospect of living and trying to find work in most parts of the US without a car is a much harsher economic penalty.

Nor is that the only punishment in the offing. A jail sentence is also a potential outcome, depending on the tenacity of a debt collector, or the indifference of a judge.

Technically speaking, no one can be imprisoned for failing to pay civil debts, though many end up behind bars because their creditors are allowed to exploit loopholes in the legal process. Loopholes abound in the patchwork of state usury laws, and some of the most gaping can be found when buying a car. Unlike student and mortgage loans, in which government agencies are involved as direct lenders or insurers, auto financing is a wholly private and unsecured market. For its part, the federal government collects very little data on this market, so borrowers and lenders are at liberty to ignore the statutory limits in the interest of making a deal. But even without these private workarounds, the complicated structure of an auto loan transaction makes it easy to exceed state usury caps.¹

In some states with no usury caps, or where loans are required only not be “unconscionable,” exorbitant interest rates are perfectly legal in auto financing. In many others, lenders and dealers evade usury caps because their loans are packaged as a “retail installment contract” (RIC). Typically, a dealer will sell a RIC to a bank or financial institution, which is then entitled to collect principal and interest payments as an “indirect lender.” These creditors could not legally lend directly to customers at rates that exceed the state-mandated cap, but they can when they buy auto RICs. The dealer takes a cut of the financial profit—a markup on the buy rate—but the right to collect the lion’s share of the returns belongs to the external lender.

Dealers and lenders operate like a tag team, trading off liability to evade regulation. Conveniently, the National Automobile Dealers Association lobbied hard to get dealerships carved out of the federal Consumer Financial Protection Bureau (CFPB), set up after the 2008 crisis, on the premise that the cratering auto industry was too weak to withstand tougher oversight. The result was a gift to lenders who call the shots in most auto transactions, and for whom the dealer is a willing front man.

The growth of subprime lending was also accelerated by the rapid emergence of a market in auto asset-backed securities (ABS), not unlike the mortgage-backed securities and collateralized debt obligations that had brought on the 2008 crash. Keen investor demand for these risky but high-yield bonds motivated lenders to actively seek out new borrowers so that their debts could be bundled into securities. Unsurprisingly, this led to looser credit and underwriting standards as creditors glossed over consumers’ ability to pay in the rush to sign up loan contracts. In 2019, for example, Moody’s found that Santander verified the income of less than 3 percent of the borrowers whose loans it sold to investors in the form of bonds.²

Santander and the other large subprime lenders—like Ally Financial, Wells Fargo, Capital One, Fifth Third Bank, Toyota Financial Services, and Credit Acceptance Corporation, considered the most rapacious of all—operate in a marketplace that is a last resort for borrowers with low credit ratings and unstable sources of income. Aside from the possibility of lawsuits (and these companies are regularly sued) their business involves surprisingly few risks. If borrowers cannot repay, repossessing the car is quick and easy, and—since sticker prices are often inflated for subprime borrowers and the actual amount of a loan can be at least twice as much as the value of the car—reselling the vehicle and recouping the balance is immensely profitable.

Buyers with tarnished credit scores are especially at risk of ending up with signed paperwork that is padded with made-up fees and add-ons. These supplements are presented as if they are built into the loan package: extended warranties, rustproofing, gap insurance, window etching, roadside assistance, service contracts, and protection packages for everything including keys, tires, wheels, paint and fabric. Dealerships make most of their profits from these add-ons, and with them, the sum payment may be twice as much as the car costs the dealer. Thanks to an industry bent on getting consumers to purchase high-status cars with more “luxury” accessories than they can afford, the last decade has seen the full-throttle promotion of long-term loans for such vehicles. In the second quarter of 2020, Experian reported that the average term of a new car loan exceeded 72 months for the first time,³ and, by the first quarter of 2021, more than 32 percent of car shoppers were signing loans for between 73 and 84 months, with the average new car loan term for those with subprime credit scores at 73.36 months.⁴ These long-term loans all but guarantee a steady increase in the number of borrowers who owe more to lenders than their car is worth.

In response to criticism about a racket designed to defraud those with few options, lobbyists for the finance industry argue that subprime and aftermarket lenders (who offer loans for tires and other auto parts) provide a lifeline for low-income consumers with no ready access to public transit and no prospect of employment without their own wheels.⁵ This is largely true. But lenders are hardly motivated by a gallant desire to help the downtrodden. They are in business because the demographic in question is the easiest to exploit, with high profit margins guaranteed. As with other debt classes, poorer households end up paying much more for cars, auto loans, and vehicle insurance than they should.

And the evidence of racial discrimination in lending is quite clear.⁶ African American borrowers in particular are charged more on all of these loan products at dealerships. A 2015 National Consumer Law Center study showed large markups on their loans in every state and region; 200 percent increases were common, but some clocked in at more than 500 percent—in one case, a Ford dealer in Wisconsin was found to have charged a 667 percent markup for Black borrowers.⁷ The financing arms of Toyota, Honda and GM have been among those forced to pay settlements for discriminating against African American and Latinx customers. Discrimination extends to insurance: In 2017, a study in auto insurance redlining by ProPublica and Consumer Reports found that some insurers were charging premiums that were on average 30 percent higher in zip codes where most residents are minorities than in whiter neighborhoods with similar accident costs.⁸

Extortionate sales conduct is endemic to the dealership and auto financing system, but fraud is even more prevalent in used car sales. The worst shakedowns occur in “Buy Here, Pay Here” (BHPH) lots that sell cheap, high-mileage vehicles at prices well above the “blue book” value to strapped consumers with little or no credit rating. These largely unregulated outlets are generally located in neighborhoods with households under extreme financial stress, and often sit on the same “Loan Alley” strips as payday lenders, pawnshops, and check-cashing facilities. Traditionally, BHPHs were “mom and pop” dealerships, but this sector is no longer unconnected to the mainstream of the finance industry. Like payday lenders and check cashing outlets, many are now consolidated and backed by Wall Street investors or bondholders, and especially the larger subprime chains like America’s Car Mart, CarMax, ByRider, and DriveTime, which also offer BHPH terms.

Auto dealers and lenders commit fraud on a routine basis; by the estimate of one former car dealer, 65 percent of auto loans involved deceptive and predatory practices.⁹ But they are much less likely to end up behind bars than those to whom they peddle cars through their con games and high-pressure sale tactics. Any lawyer will tell you that it is illegal in the US to be arrested or jailed for failing to pay consumer debts, but there are dozens of states in which civil debtors still find themselves behind bars or threatened with jail time. The driving force in these situations are debt collectors.¹⁰ Although they are regulated by federal and state consumer collection laws, and by the Fair Debt Collection Practice Act—which prohibits collectors from using the threat of criminal prosecution for failing to pay a debt—creditors and their enforcers still find it remarkably easy to manipulate the justice system in order to incarcerate delinquent borrowers.

The opportunity arises when judges, at the request of collection agencies, issue arrest warrants for failure to appear in court on unpaid civil debt judgments. Debtors face arrest and jail time not for the delinquency itself, but for contempt of court. From their perspective, however, the distinction doesn’t make a whole lot of difference. There are forty-four states that allow this to happen, even when it is obvious that debtors cannot pay, or when their debts are still being disputed. The practice, which also includes incarceration for unpaid child support or divorce proceedings, is so common that the lead author of a 2018 ACLU report on the criminalization of private debt declared that the “courts have been completely co-opted by the debt-collection industry.”¹¹

With a willing prosecutor or judge, the process is relatively straightforward. In civil court, a creditor obtains a money judgment against a debtor who cannot pay off a car, or an auto title, loan. Debtors are represented by lawyers in just 2 percent of such cases, according to the Federal Trade Commission, and so it is not surprising that debt collectors win 95 percent of them. The court can issue a wage garnishment order or otherwise authorize the seizure of assets, including from bank account funds. If collectors still cannot extract enough to cover the loan balance, they can ask the court to schedule a post-judgement debtor’s examination, ostensibly to inquire about the borrower’s finances. If debtors fail to respond to an order to appear, they are found to be in civil contempt, and an arrest warrant can follow. Those who end up in jail are required to post a bond that typically corresponds to the amount of the debt. Though technically arrested for contempt, in effect, they are behind bars for a debt they cannot pay.

In many states, an increasingly prevalent tactic deployed by payday and auto title lenders is to sue delinquent borrowers under a “theft by check” law. Typically, these kinds of creditors require borrowers to provide a post-dated check or access to their bank account in order to secure a loan. When the account cannot cover the amount of the check, they are sued for fraud or theft. The violation may be treated as a misdemeanor, carrying a potential jail sentence, but it can also be considered a felony if the sum is large enough.

In a 2020 study of Utah courts, the Consumer Federation of America found that high-cost lenders who used these tactics were dominating small-claims court dockets, and were the most aggressive plaintiffs, suing over smaller amounts and litigating for much longer than other plaintiffs. The median debt in dispute was as low as $994, and three out of ten high-cost lender lawsuits resulted in a warrant for the arrest of the borrower for contempt of court. The report concluded that “small-claims courts—originally designed to improve access to justice for average Americans—are now primarily used by usurious lenders to aggressively collect triple-digit interest rates from poor, insolvent borrowers.”¹² Studies in other states showed a similar increase in the volume of criminal charges being filed for relatively small loan amounts, and a pattern of disproportionately targeting debtors of color.¹³

For most debtors who find themselves funneled into this debt-to-jail pipeline, their only real misdeed is their poverty. They are legally hounded and punished because, and in spite of, their hardship, and are deprived of their liberty for small sums of money that can be spun into larger, and more profitable, liabilities through the court process. While only a minority of these judgments result in jail time, the threat of incarceration is an extremely effective way of forcing debtors to seek out funds to make their payments, indirectly encouraging actual criminal activity. The consumers whom predatory lenders choose to target have the least resources and yet they are burned the most. By contrast, auto buyers who can afford to pay upfront or secure cheap loans have the smoothest ride.

Indebtedness should not ever lead to detention, and the loopholes and back doors that creditors find at their disposal should be firmly closed off. But even in the absence of an arrest threat, car debt is itself a powerful form of social discipline and control. While auto loans are now the price of our access to physical mobility, the steep cost of their debt service sets limits on other forms of mobility, constraining drivers’ financial choices and enforcing social norms about unswerving obedience to defrauding creditors. For most of us, our cars, no matter how much we cherish them, hold us in social and economic custody. As more and more vehicles are financed, and with higher loans and interest rates, creditors exert a carceral pull over our ability to earn a sustainable livelihood. Perhaps the most telling evidence of this servitude is that, in times of financial stress, households will prioritize their monthly car payments over all others, including basic necessities. Surely it is the mark of our perverse civilization when food, medical care, and housing have to take a back seat to our need to keep wheels on the road.

Yet this is the natural outcome of a creditocracy, where indebtedness becomes the precondition not just for material improvements in the quality of life, but for the basic requirements of life: where one in three Americans with a credit record are pursued by debt collectors;¹⁴ where fear of a damaged credit score governs our conduct; and where the ideal citizens are “revolvers,” who fail to make monthly payments and resort to rolling over their debts, with penalties, ensuring they are kept on the hook as revenue-generators indefinitely.¹⁵ Even more than housing—still by far the single largest component of household debt—the acquisition and use of cars engenders multiple kinds of debt service; for purchase, repairs, licensing, maintenance, insurance, traffic violations, court fines and fees, and medical costs in the event of accidents. The result is a rolling feast of revenue for creditors in each of these sectors, with the full force of the courts to back up the extraction of profit.

By contrast, for many if not most owners, the compounding costs and risks of owning a private vehicle would surely outweigh its economic benefits if it were not such a necessary asset. First and foremost, there is the depreciating value of the car. Second, there is the draining experience of paying back more than the car’s original worth, or of prolonging the losses by rolling over a balance into a new loan on another car. Then there is a significant risk of a sheer loss, in the form of a crash or a repossession. And, at the end of it all, the equally ruinous prospect of a jail sentence. Few other investments, with the exception of yachts, are such a losing proposition. Yet it is probably the only one we cannot afford to reject.