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Rising Delinquencies: Unpacking the Subprime Market’s Effect on Lending

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The subprime market, which encompasses borrowers with lower credit scores, has been experiencing a notable upsurge in delinquencies, particularly in the auto loan sector. This trend has significant implications for business lending, as it reflects broader financial pressures faced by American households.

Consumers with low credit scores are falling behind on their auto loans at an unprecedented rate, with the share of payments on so-called “subprime” auto loans that were at least 60 days late rising to over 6% in December 2022. This rate is a record, surpassing previous peaks just prior to the pandemic​.

The surge in subprime delinquencies can be attributed to several key factors. Despite a robust job market, American households are grappling with increased cost-of-living pressures. The Consumer Price Index has soared more than 14% over the past two years, leading to financial strain for many. Additionally, the termination of key COVID-era federal aid programs, such as the Child Tax Credit and expanded unemployment benefits, has left households without essential financial support. Compounding these challenges, many Americans have seen their savings levels decline, and credit card usage is on the rise, even as interest rates on these borrowings reach record highs.

The subprime market also experienced a surge in borrowing activity during the pandemic, driven in part by skyrocketing used vehicle prices. Consumers with low credit scores, who predominantly purchase used vehicles rather than new ones, took on higher borrowing costs. However, these higher costs are becoming increasingly difficult to manage, contributing to the rise in delinquencies​.

The implications of these trends for business lending are significant. As consumers face financial pressure and the risk of default rises, lenders may tighten credit standards and reduce access to financing. Subprime borrowers, who are already considered high risk, may find it increasingly challenging to secure loans for personal or business purposes. Small businesses and entrepreneurs who rely on personal credit to finance their ventures may be particularly affected.

Moreover, the ripple effects of subprime market challenges could extend beyond auto loans and impact other areas, including the mortgage market. As such, it is crucial to monitor whether these cost pressures will spread to a larger share of Americans, leading to an even greater increase in delinquencies across various loan types.

In conclusion, the current state of the subprime market underscores the importance of prudent lending practices and robust financial support mechanisms for vulnerable households. While the subprime market is inherently higher risk, addressing these issues and providing consumers with the tools to manage financial stress can help mitigate the risks and contribute to a more stable lending environment.