The Breakdown: Car loan exploitation

What's going on?

People are buying cars they can't afford and government regulators are sick of it.

The Australian Securities and Investment Commission has gone after credit providers ranging from dodgy outback car dealerships to global automotive powerhouses, small-time loan centres and one of the big four banks to protect consumers from exploitative practices... and themselves.

This week, Motor Finance Wizard agreed to cop more than $11 million in refunds and write-offs to more than 1500 customers who signed up for a vehicle lease or loan between July 2010 and July 2014.

While it isn't exactly a household name, you might remember the Motor Finance Wizard jingle from its television ads. Sing it with me:

"Motor Finance Wizard says yes!"

You get the idea.

The promise was that anyone could get a car loan from Motor Finance Wizard, even if banks, dealerships, credit unions and your wealthy old uncle said no.

Check out the sober blurb presented to consumers who pop over to the Wizard's website and apply for a loan:

"We consider everyone! Apply now, even if you are an ex-bankrupt, have bad or no credit history, are unemployed, self-employed, a pensioner or sole parent."

The company used its own formula to assess the finances of potential customers before doling out loans for used cars. Australian consumer authorities have questioned the Wizard's in-house blend of fiscal sorcery, and ASIC deputy chair Peter Kell says Motor Finance Wizard failed to meet responsible lending obligations by neglecting to ask customers about their financial circumstances, or to verify their reported expenses.  

This is not an isolated case.

On a much smaller scale, in 2016 ASIC pursued Queensland car dealer Colin William Hulbert, who was found to have breached consumer protection laws by exploiting people in the isolated Aboriginal community of Yarrabah.

Hubert's second-hand car yard, Super Cheap Car Sales, charged customers $550 to $990 in fees to access his own financial brokering service, Cash Brokers Pty Ltd, which then sourced car loans from Cairns-based lending outfit, Channic Pty Ltd, which he also owned and operated..

ASIC says Channic charged 48 per cent interest on vehicle loans to vulnerable customers who were not properly vetted.

At the other end of the spectrum, BMW Australia Finance agreed to pay $77 million in December 2016 as part of Australia's largest consumer credit remediation program, committing to $14.6 million in cash-back remediation payments as well as $7.6 million in interest rate reductions and $50 million in loan write-offs to more than 15,000 customers. 

The luxury brand also has to contribute $5 million to community financial literacy programs.

BMW had already been stung twice, in 2015 and 2016, for breaching consumer provisions surrounding the repossession of vehicles, and it has had strict conditions placed on its financial license. The car maker has to buy back debt it sold to third-party collectors, and submit to oversight from an independent advisor who ensures the company isn't selling car loans to people who can't afford to pay their bills.

ASIC slammed BMW for having "a sales-driven culture that failed to comply with the requirements of the credit laws and resulted in poor outcomes for many consumers".

The government authority has hinted BMW isn't the only car company that may have failed to comply with local laws. It has also taken on Westpac's Capital Finance car financier for breaching automotive repossession requirements.

Overseas, the US state of Massachusetts reached a $US22 million settlement with Santander bank in March, as the bank failed to do its homework when guaranteeing car loans. 

Santander reportedly verified income on just 8 per cent of car loans, failing to do due diligence on many of its automotive deals.

Why the big deal?

Christian Bale starred in The Big Short, a film exploring sub-prime mortgages.

Remember the global financial crisis that blew up around a decade ago?

That was triggered in part by sub-prime mortgages, or home loans issued to people with less-than-ideal financial circumstances (classified in a 'sub-prime' credit bracket) who could not afford to make repayments. 

Wizards of the American home loan world issued ambitious mortgages to NINJAs - people with no income, jobs or assets - leaving people deep in debt on properties that soon became worth less than what they owed. So people defaulted on their mortgage, declared bankruptcy or simply walked away, causing banks to either collapse or be bailed out at immense cost to taxpayers.

The same thing is starting to happening in the automotive world, particularly in the US, only this time people are buying cars they can't afford. 

Citing Morgan Stanley data, respected car industry publisher Wards Auto reports that risky "deep sub-prime" car loans have "risen from 5.1 per cent in 2010 to 32.5 per cent today".

According to Wards Auto, US consumer spending on cars grew by 36 per cent between 2009 and 2016, while wages grew by 15 per cent. Further data suggests the average amount of debt held attached to vehicles in the US increased by 44 per cent in the same period.

Santander has been busted for failing to examine whether people are eligible for car loans, while a UBS banking survey found that one-in-five people seeking car loans submitted applications that "contained inaccuracies".

Bloomberg reports that around 1 per cent of new car loan applicants in the US flat-out lie about their financial circumstances, matching the rate of mortgage fraud surrounding sub-prime mortgages in 2009.

US motorists owed $US1.1 to $1.2 trillion in outstanding car loan payments at the end of 2016, and financial vetting firm Point Predictive estimates that losses from car loan fraud will double from $US2-4 billion in 2015 to $US4-6 billion by the end of this year.

The American culture surrounding car loans shifted after the global financial crisis, our Great Recession, as manufacturers and dealers tried to stimulate a flagging industry by relaxing requirements on new vehicle loans. Cars are loaned or leased for longer terms than before - US research firm Moody's reports almost one third of loans last longer than six years - in many cases longer than people choose to keep a new car. 

Long repayment periods with small deposits and modest repayment requirements mean that people looking for a new car often owe money on their trade-in, so they roll negative equity into their next car loan.

The LA Times reports that one third of US buyers who trade in a car for a new vehicle owe money on the old one, sitting "underwater" or "upside down" at an average of $5000.

Who cares?

Economists are getting itchy about the automotive sub-prime situation in the US. To be clear, it's not nearly as serious as the mortgage crisis, as the sums involved are much smaller and banks are far less exposed than they were in 2009.

But the car industry isn't as healthy as it could be. The US market is contracting after years of growth and the same is true in Australia, where the market is down nearly 3 per cent on 2016's record high.

The car industry needs to care about this issue, as governments clearly do. Consumers also need to take responsibility for their spending, and buy a car they can afford rather than the most impressive vehicle a dealership will let them take out of the showroom.

Australian automotive research group ACA Research says many customers appear to put little thought into exactly how they will pay for new cars.

A 2016 report by ACA states that "more than one third of consumers are not considering finance until the last week, with more than half making the final choice of lender at this time". It says 34 per cent of motorists source finance through car dealerships, which can have its pitfalls.

Say what?

These days, Motor Finance Wizard says no:

"Unfortunately our lending criteria has changed and we no longer provide finance options to unemployed applicants."

ASIC deputy chair Peter Kell on BMW:

"This is an example of the staggering cost of poor business practices and should act as a warning to other car financiers to get their houses in order."

Massachusetts Attorney General Maura Healey:

"These predatory practices are almost identical to what we saw in the mortgage industry a few years ago."

Euromonitor International analyst Eric Totaro on a change to car loans:

"Intelligent automakers and lenders must increase their conservatism now to protect themselves against a future car-credit bubble... [they] should promote cheaper vehicles that consumers can afford by marketing less feature-laden models"

What next?

Keen to stamp out the sort of irresponsible lending behaviour that triggered the 2009 crisis, legislators are tightening their hold on the car industry at home and abroad.

When Federal Government agencies aren't ripping in to dealerships over lending practices, they are chasing Volkswagen over the diesel emissions scandal, examining service and warranty arrangements, weighing up the option of letting people cut out dealers to import new cars directly from overseas sources, sizing up new emissions laws and more.

ASIC announced in March that it will prohibit "flex commissions" in car finance, preventing car dealers from arranging loans at higher interest than the lowest available finance rates - a setup that generated extra revenue for banks and sales staff at the expense of customers, who unwittingly paid more than they needed to.

Arrangements established between finance companies and car dealers paid cash incentives to sales staff who were able to convince customers to commit to high interest rates. One example stated by ASIC shows that a dealership that sold a car for the minimum applicable 6.24 per cent interest rate would receive a flexible commission of $346, whereas a sale that locked the customer into paying a 13.04 per cent rate earned the sales outlet a $3173 bonus.

In March Kell said that "most consumers would be surprised to learn that when you are buying a car on finance, the car dealer can, for example, decide whether you will be charged an interest rate of 7 per cent or one of 14 per cent - regardless of your credit history", criticising the car industry for failing to operate in a "fair and transparent" way.

Kell says average interest rates on car loans will fall as a result of "more efficient pricing models and lower losses through defaults", and car sales staff are likely to be more diligent in making sure their deals comply with consumer credit laws.

The tricky part here is that car companies need to sell cars to stay alive. 

Euromonitor International analyst Eric Totaro says manufacturers "should promote cheaper vehicles that consumers can afford by marketing less feature-laden models". But that doesn't fit with the booming global trend toward SUVs and luxury models, one that seems to have no end in sight.

It may be that the only way to solve the automotive lending problem is for motorists to buy what they need as opposed to what they want, and drive within their means.