Americans owe auto lenders well over a trillion dollars. Consumers with subprime credit scores ─ i.e. scores that are significantly lower than average ─ are especially likely to need loans to purchase vehicles. But they also pay the highest interest rates and are the most likely to default on their loans. Because interest rates and default risk can matter so much for consumers, our takes an in-depth look at how they vary across different types of subprime auto lenders. It finds that some types of subprime lenders charge their borrowers significantly higher interest rates than others, and that differences in default risk are unlikely to fully explain these differences.
The Data Point first finds that there are notable differences across lender types in the borrowers they serve and the types of vehicles they finance. For example, banks and credit unions that offer subprime auto loans tend to lend to borrowers with higher credit scores than finance companies and buy-here-pay-here dealerships. In light of these differences, it is perhaps not surprising that different lender types charge very different interest rates on average. For example, for subprime auto loans in our sample, average interest rates at banks are approximately 10 percent, compared to 15 percent to 20 percent at finance companies and buy-here-pay-here dealerships. As expected, we find higher default rates at lender types that charge higher interest rates. For example, we find that the likelihood of a subprime auto loan becoming at least 60 days delinquent within three years is approximately 15 percent for bank borrowers and between 25 percent and 40 percent for finance company and buy-here-pay-here borrowers.
But do differences in default risk fully explain the differences in interest rates across subprime lender types that we see? Our statistical analysis suggests they do not. For example, adjusting for many factors in our data that we observe (such as borrowers’ credit scores), we estimate that the average borrower in our data with a 560+ credit score would have the same default risk with a loan from a bank as with a loan from a small buy-here-pay-here lender. But their estimated interest rate would be 13 percent with a loan from a small buy-here-pay-here lender, while it would be 9 percent with a loan from a bank. In our data, a typical borrower at a small buy-here-pay-here lender would save around $900 over the life of a loan if they could reduce their interest rate from 13 percent to 9 percent.
There are variables we do not observe in our data that could explain these interest rate differences, such as borrowers’ down payments. In the report we discuss many other reasons that interest rates could vary across lender types, including variation in borrowers’ access to information and financial sophistication and variation in lenders’ business practices and incentives. Our data don’t allow us to confidently distinguish between these reasons, but we present some preliminary evidence from our data on these issues and suggest directions for future research.