One event that is occurring is the greater availability of credit for borrowers with weaker credit histories. After the severe recession in 2008/2009 credit standards were tightened across all loan categories. This has been changing, as credit is becoming more available compared to the past several years.
One area that has seen a significant increase in subprime lending is auto loans. The greater availability of credit has been a significant factor in the recent strength of car sales. However, delinquency trends are starting to increase in the auto lending sector.
Normally, when the economy is expanding, delinquency trends tend to drop. This makes intuitive sense, as when the unemployment rate is falling less people should be behind on their payments. This is currently the case among mortgage lending and credit cards, which have been showing improving trends since the last recession ended.
Generally there are two factors that would impact delinquency trends. One is the ability to pay, and the other is when the asset is worth less than the loan. For mortgage lending, when property values are rising, delinquency trends, would tend to be lower. Even if a homeowner loses their job, that person will make a stronger effort to stay current on their payments, if they have equity in the property.
Cars on the other hand are a depreciating asset, so it is much more likely that someone may have an auto loan that is greater than the value of their car. When lending standards are fairly lax, such as when people with low downpayments can purchase cars, the likelihood of greater delinquencies increases. That is what we are currently seeing, despite the unemployment rate falling.
Credit is often referred to as the lifeblood of the economy. This is applicable to both consumer and business lending. When credit standards are unusually tight the economy tends to do poorly. When credit standards are looser, the economy tends to get a boost, but there may be negative consequences down the road.
For consumers with weaker credit histories a greater availability of credit could be both a positive or a negative. It is a positive, in that it is better to have a loan paying 15 to 20 percent interest versus going to a payday lender, where the annual interest rate would be well over a 100 percent.
The negative is that it tends to encourage people to make purchases, which they may not have the ability to afford. Having an interest rate in the double digits is still a major burden, while someone with good credit might be able to get their auto loan with a rate around 3 percent. For some people, it would be best that they defer making purchases on any discretionary items, until their financial situation is stronger.
Lending standards in our economy have tended to vacillate from one extreme to the other. At the present time lending standards are clearly easing. That is certainly helping out the economy to some extent, at the present time.
While I have discussed looser auto lending standards, mortgage-lending terms are also starting to become more favorable. If we begin to see a greater percentage of mortgage loans being made to low down payment borrowers, the likelihood of greater delinquencies increases. Property values are strong currently, especially in our area, so this is not likely to become a problem near term.
The recent increase in subprime lending activity is providing a boost to the economy. However, it is important for investors to focus on delinquency trends. Other than high delinquencies among student loans, which is a well recognized long term problem, other delinquency trends are reasonably favorable, other than a recent small increase among auto loans.
For now, the outlook for the economy looks to be quite favorable. However, longer term I would tend to focus on delinquency trends in the mortgage industry, if subprime lending increases significantly in that area.