Auto loans could pose a bigger threat to young Americans than student loans

The Covid-era student loan payment hiatus ends on Oct. 1 and borrowers and economists are alarmed.

Borrowers, on average, will have to pony up about $390 a month to service their loans, while economists expect a hit to U.S. consumer spending of $15.8 billion per month.

That might be the least of the financial challenges ahead for young borrowers. According to the New York Fed, for the first time the outstanding volume of auto loan debt just surpassed student loan debt.

Auto loan debt now totals $1.582 trillion, compared with $1.569 trillion in outstanding student loans.

The volume of auto loans has doubled in the past ten years, and the market has grown especially quickly during the last three as car prices have skyrocketed due to Covid supply chain interruptions and other factors.

That makes auto loan debt the second-largest type of consumer borrowing, after residential mortgages

Stretching already stretched budgets

U.S. households’ average monthly expenses total $6,081, according to the Bureau of Labor Statistics’ 2022 Consumer Expenditures Survey. That means the average student loan payment will boost a household’s expenses by more than 6%.

This is particularly onerous for young borrowers who are just starting out in their careers and have limited incomes.

This group of borrowers already has trouble making auto loan payments. Auto loan delinquencies hit 3.59% in August, a level only exceeded in 2010 at the tail end of the Great Recession, and in 2020 during the Covid mini-recession.

Student loan delinquencies, by contrast, were about 11% before the Covid payment pause and have been consistently above 10% since 2012.

About one-third of federal student loan borrowers have defaulted—meaning they've gone at least 270 days (9 months) without making a payment—at some point in the past two decades according to a survey done for The Pew Charitable Trusts.

And among this group, two-thirds have defaulted multiple times.

Despite having lower overall default rates than student loans, the auto loan market has economists worried.

The Consumer Financial Protection Bureau (CFPB)—the government watchdog established in 2010 after the financial crisis—launched a project to gather auto loan performance data to better understand the risks in the auto loan market.

Student loans are government-guaranteed, so there is plenty of good information about them. And mortgages—the biggest type of consumer debt—are extended by government-regulated banks, so there is also data aplenty there.

Auto loans, on the other hand, are often extended by third-party entities like the finance subsidiaries of car companies. This makes it difficult to get a good read on the market, a problem the CFPB is now trying to remedy.

Even without comprehensive information, the CFPB says that recent data show increased auto loan delinquencies, particularly for low-income consumers and those with subprime credit scores.

Data from the Fed concurs, showing that people ages 18-29 currently have the highest delinquency rates. The CFPB also sees evidence that some consumers may be getting priced out of the current market.

Subprime auto loans are the pain point

A prime borrower is considered to have almost no default risk because their credit history demonstrates they’re very likely to make loan payments on time.

Loans to prime-rated borrowers, therefore, have a delinquency rate of only 0.2%. Prime auto loans also comprise the bulk of the market—about 86%.

The problems are concentrated in subprime auto loans, which have a relatively high credit risk for lenders. Despite the seemingly strong economy, these loans have been defaulting more than they have in the past.

This past April was the second worst on record for subprime delinquencies, with 4.67% of subprime auto loans becoming delinquent, second only to April 2020 during the first part of the Covid crisis.

Throwing gasoline on the fire

The prospect of having significant delinquencies in both the second- and third-largest consumer loan markets is unsettling for all parties involved.

At least some of those subprime auto borrowers who are already struggling could likely be pushed into outright default when the student loan repayments kick in.

This situation might not be seen as a national emergency at a time when the Fed is desperately trying to rein in the economy to battle inflation. But it will certainly be a personal crisis for those borrowers who find themselves stretched to their limits.