We take credit for granted nowadays – credit cards, mortgages, car loans, etc. – but it was not always so. Installment sales date back to the Civil War era, and by the early 20th century, consumer goods like washing machines and phonographs were often purchased on an installment plan. However, it was the car industry that accelerated the use of credit, and America hasn’t looked back since. Here are some of the important events in the history of the auto lending industry.
The first mass-produced automobile, the Ford Model-T, was introduced in 1908. Its original cost, $850, translates into more than $20,000 in present-day dollar value. Most prospective buyers had to save for years in order to pay cash for the Model-T, so the need for financing was clear. Some dealerships offered installment loans, but it was a Wild West environment with little regulation.
The General Motors Acceptance Corporation was formed by GM in 1919 to provide customers with car loans. It was the brainchild of GM President Alfred P. Sloan as a way for consumers to buy cars without having a lot of upfront cash. Originally located in five large North American cities, it eventually became a nationwide behemoth as it expanded into banking, insurance, mortgages, and commercial finance.
The early loans required 35 percent down, with the remainder due in installments over the period of one year. GMAC wanted to recoup its loans quickly before consumers began shelling out money to repair their cars.
In 2006, GMAC was taken private by Cerberus Capital Management. Then, in 2008 it became a bank holding company and qualified for a 17.2 billion bailout from the U.S. Treasury. In 2009, GMAC changed its name to Ally Bank, and in 2010, Ally Financial.
Ally finished repaying the Treasury in 2014, shelling out $19.6 billion in total. In the same year it recapitalized itself as a public company. Currently, the Ally Auto division provides credit to more than four million retail consumers and 18,000 automobile dealerships.
Ford Motor Company took a different route because Henry Ford was not a fan of using debt to finance a car. Instead, it adopted its Weekly Payment Plan, an installment loan requiring a down payment and weekly payments of $5 to $10. The money was placed in a local Ford dealer’s account, and only when the full purchase price was deposited could the customer take delivery.
The Weekly Payment Plan fizzled as Americans wanted nice cars on credit and were unwilling to wait. This helped catapult General Motors into the lead among car manufacturers. In 1928, Ford set up an auto loan subsidiary. Now its customers could set up installment loans and take delivery all at once. By 1930, about two-thirds of all cars were bought on credit.
In 1959, Ford Motor Credit Company LLC was founded to take over car financing/leasing operations for customers and dealerships. Ford Credit is still owned by Ford Motor Company – the GM and Chrysler financial units have been spun off.
The mid-century advent of vehicle identification numbers (VINs) inspired lenders to demand them before issuing car loans. This helped to remove an element of risk in the industry. Speaking of demand, the 1956 Federal Aid Highway Act which created the U.S. Interstate System fueled demand for automobiles and enlarged the market for car financing.
In that same year the Fair Isaac Company created the first FICO score which quickly became a popular way to quantify borrowers’ creditworthiness. The car finance companies began using these scores, and by the 1970s they were a cornerstone of risk underwriting, as they still are today.
The auto lending market is composed of captive lenders (finance companies tied to car manufacturers), commercial banks, credit unions, and other lenders. Most car brands (excluding GM and Fiat/Chrysler) have a financial arm, i.e., Ford Credit, Honda Financial Services, Toyota Financial Services, Nissan Motor Acceptance Corporation, etc.
By the end of 2016 banks made up 35.6 percent of all U.S. auto loans. The five largest banks in this market – Chase, Ally, Wells Fargo, Capital One, and Bank of America – make up 25 percent of the market, or 70 percent of the commercial bank share. Credit unions account for $39 billion in open auto loans.
The average new car loan exceeds $30,000 with an average term of 68 months. The average used car loan for prime consumers is more than $20,000. Loans that are 60 or more days delinquent make up 0.78 percent of the car loan market.
Laws and Regulations
Several federal and state laws protect consumer rights when buying or leasing an automobile. The aim of these laws is to ensure buyers receive a full disclosure of fees and terms. Some important ones are:
- Truth in Lending Act (1968): Standardizes the way costs and terms are disclosed. The Act introduced the calculation of the Annual Percentage Rate, which incorporates all costs and fees, not just interest. However, in the 1980s, automobile lenders began using a loophole in the law to obfuscate the APR. They can offer a zero percent APR or a rebate. However, you effectively pay the rebate to get the zero percent APR. This is a deal only a captive auto financing arm can arrange, giving them an unfair advantage over banks and other lenders.
- Consumer Leasing Act (1976): Regulates the disclosure of lease terms and costs. Originally part of the Truth in Lending Act, it was revised and separately implemented in 1981 as Regulation M. The Act also specifies the information that must be provided in advertisements for leases.
- Risk-Based Pricing Rule (2011): This rule requires lenders to explain why a consumer with poor credit is receiving a less favorable APR than a consumer with good credit. The explanation takes the form of a Risk-Based Pricing Notice.
- Fair Debt Collection Practices Act (1977): Sets the rules for debt collection and protects against abusive practices, including the use of threatening language, contact by embarrassing media, communication with third parties, and much more. The Act extends certain rights to borrowers who are behind on their payments, including verification of debt and notification of a consumer’s right to dispute a debt.