August 12, 2021 – Unlike mortgages, which under Dodd-Frank now require a “ability to pay” assessment by lenders, there is no such standard for subprime auto loans. But with the changing political winds in Washington, will the Consumer Financial Protection Bureau (CFPB) or Congress attempt to create something similar for auto loans? If this happens, will it completely transform the subprime auto loan landscape?
It would be an extreme change for sure. But with a 2020 lawsuit against Credit Acceptance Corporation filed by the Massachusetts Attorney General that primarily focuses on issues related to the ability of borrowers to repay their loans, it is not excluded that “ability to pay” will become a problem. new risk. to consider in subprime auto loans.
Of course, auto loans and mortgages have different characteristics, prices, and risks. A key difference is collateral collections and the ability to reduce the severity of losses. When mortgage lenders pursue legal remedies, the costs associated with foreclosure can act as a deterrent. In contrast, in automatic loans, defaults can often be remedied by prompt non-judicial repossessions. It’s a process that has shortcuts and cost-saving measures (startup interrupt devices, GPS tracking), and it can even generate income for lenders who also operate as debt collectors. Even investors in risky auto securitizations are well insulated by transaction structures.
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But lawmakers and regulators are concerned about the financial well-being of the most vulnerable borrowers and often view the subprime landscape as taking advantage of low-income, underserved, and potentially racially prejudiced consumers.
Unlike housing, where renting often offers a less expensive alternative to home ownership, there is arguably no lower cost option in the automobile. In the long run, leasing and renting cars are relatively more expensive than owning your own vehicle, and owning your own vehicle has only grown in importance during the pandemic as consumers seek to avoid transit and covet the ability to control their individual environment for health and safety. the reasons.
If there are tweaks to access to credit, it could tip the balance too far, leaving borrowers at risk with little or no path to homeownership (or they are so pushed into affordability margins that their only option becomes unscrupulous businesses with suspicious or fraudulent practices).
The 2020 allegations against Credit Acceptance Corporation (CAC) shed light on how “ability to pay” can be used against a subprime auto lender. There, the fundamental conclusion drawn by the Massachusetts AG was “[a] loan that the lender does not reasonably believe the borrower is able to repay is an unfair loan “and therefore a violation of state laws on Unfair and Deceptive Acts and Practices (UDAP).
The GA emphasized that more than 50% of loans granted by the CAC end up in default. The premise being that such a large number of defaults occur because the entire business model of CAC is not based on the borrower’s ability to repay, but rather, CAC is able to profit from collections and payment defaults. In 2021, the CAC reached an agreement in principle to settle these issues with the state.
There were warning signs even before the ACC action. Santander settled with 34 state attorneys general in 2020 on similar issues of subprime auto loan granting, knowing that they had a high probability of default (and also ignoring the bad conduct of dealers on these loans whose income had often been inflated). In 2017, Santander again settled similar charges in Massachusetts and Delaware, where the allegations focused on financing loans without a reasonable basis on which to believe borrowers could afford the loans.
In July 2021, Santander settled down a four-year-old dispute with the Mississippi state attorney general over its past auto loan practices and must “rely on a consumer’s ability to repay a loan” in the future. The CAC’s action may now pave the way for other state attorneys general who interpret their own UDAP laws in a way that penalizes other lenders for similar conduct.
We have already seen the interim director of the CFPB, Dave Uejio, say that he supports the ability to pay rules in the payday lending and auto securities lending contexts under CFPB’s power to regulate Unfair, Deceptive and Abusive Acts and Practices (UDAAP).
But previous efforts were a false start. In 2017, the CFPB issued rule for payday loans and auto titles which required lenders to determine that the borrower had sufficient income to pay off the loan and meet financial obligations during its term plus 30 days after repayment. But in 2020, the CFPB repealed the underwriting elements of the 2017 rule, including the rule that it was unfair to grant such loans without reasonably determining that consumers had the capacity to repay.
Uejio’s comments in 2021 suggest a return to that previous perspective, although his statement first suggests that the office “will use the authority provided by Congress to remedy this damage, including through surveillance, vigorous market surveillance and enforcement, “and secondarily,” where appropriate, rule-making. ” As recently as last month, he stressed the importance of this approach for payday loans. It may be more of a slow start this time, than a false start.
Under the UDAAP and UDAP standards, the CFPB and state attorneys general have long focused their individual enforcement efforts on those accused of wrongdoing in repossession, collection, and sales practices. As we have seen, state attorneys general have even used the UDAP to challenge underwriting practices. If there is greater application in the future, look for an increase in coordinated efforts at the federal and state levels. Senator Elizabeth Warren recently appealed to the CFPB to specifically increase control over auto loans. “Warren Calls for CFPB Review of Overdraft Fee, Crypto,” Law360, July 19, 2021.
But it’s a precarious time to change the regulatory landscape. The most productive regulations and policies balance the need for access to credit by underserved consumers with the need to protect them from unfair and predatory practices. Even in the area of student loans, questions continue to arise regarding parent PLUS loans which are granted without regard to the borrower’s ability to pay. This has raised the question of how to best balance the social interest of ensuring that consumers have access to this type of credit while not plunging them into damaging cycles of debt from which they cannot escape.
In such turbulent times, as we (hopefully) move from a period of massive government aid to a booming economic recovery, a regulatory regime that makes it harder to get loans could disrupt or amplify trends. of the market. Even without regulatory changes, creations of risky cars fell during the pandemic due to tightening underwriting.
It appears for now that the likely route to consumer protection will be enforcement, but if performance deteriorates post-pandemic consumer protection concerns could escalate and a more aggressive route – regulation and legislation – could be on the horizon for auto subprime mortgages.
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