Why You Shouldn't Worry About Rising Auto Loan Debt

Low loan-to-income ratios and cheap credit should keep borrowers in the clear

Production Of KIA Motors Corp. And Hyundai Automobiles At The Hyundai Motor Manufacturing RUS Assembly Plant
Photographer: Andrey Rudakov/Bloomberg

Car loans in the U.S. are soaring, but don't expect a crash any time soon.

Personal income gains, coupled with historically low interest rates, should help cushion borrowers and reduce the likelihood of a rise in defaults despite the recent increase in auto lending, according to a new report from London-based Capital Economics Ltd.

The total of outstanding car loans in the U.S. reached $1.1 trillion in the fourth quarter of 2015, according to Federal Reserve Bank of New York data. That's up more than 30 percent from its pre-crisis peak, reflecting last year's record surge in vehicle sales, and compares with a decline of 2 percent in overall household borrowing in the same period.

What's drawn particular attention: auto loans to people with credit scores below 620—borrowers with the poorest credit—have increased more than 150 percent from the market bottom six years ago, compared with a 98 percent rise in overall auto lending in that period. Loans made to those borrowers still comprised a relatively small share of all originations last quarter at about 22 percent, up from 17 percent in 2009. 



While the total balance of auto loans outstanding has climbed well above its pre-recession peak, auto debt as a share of personal disposable income has held below its pre-crisis high, as the chart above shows. 

The loan to disposable income ratio offers a more accurate measure of a borrower's ability to pay off debt, according to Andrew Hunter, an economist at Capital Economics and author of the report.

"The total value, and indeed growth, of auto loan debt in itself is fairly meaningless," he said. "What matters is the ability of households to service that debt, which is determined by their disposable income."

A Labor Department report Friday showed that the U.S. workforce is growing at the fastest pace in more than a decade and unemployment held at an eight-year low of 4.9 percent in February even as more Americans piled into the job market.

"Even though growth in average hourly earnings has remained fairly muted in recent years," Hunter said, strengthening employment "has still been enough to keep incomes growing at a decent rate."

Meanwhile, he says historically low interest rates should limit delinquencies. Rates on 48-month new-car loans from commercial banks fell to 4 percent in the fourth quarter of 2015, nearly half the 7.92 percent rate in the same period of 2006.

Borrowing costs won't stay low forever: The Fed raised interest rates in December for the first time in almost a decade. Fed officials say they will make further moves gradually, though, and Hunter said higher rates are "unlikely to be a major threat," especially because most borrowers are on fixed-rate loans.

"Of course there is always the risk of some external shock to the economy which could lead to a drop in incomes," Hunter said. "But we think the economy is in pretty healthy shape and expect incomes to continue growing at a decent rate for the foreseeable future."

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