While car ownership is standard today, there was a period of time in American history when it was quite rare. Households did not anticipate the introduction of affordable mass-produced vehicles in 1920, nor how essential they would become to the American lifestyle. Nevertheless, it only took around ten years for half of all US households to acquire a car.
How did Americans afford this new expense? It all started in the early 1900’s, when auto financing was born.
A Consumer Revolution
Throughout the early twentieth century, America saw a number of technological innovations enter the consumer market. Chief among these was the automobile. The Ford Model T was the first affordable car, dropping in price from $900 in 1910 to $395 in 1920. Considering inflation, this would be equivalent to a price drop today from $22,000 to $4,750. Cheaper vehicles opened a world of possibilities to the middle-class.
However, the introduction of automobiles to the consumer market brought about a new problem: the cost of a new car was still something that many American households could not afford. Auto financing was the solution to this conundrum. General Motors invented the credit system by loaning consumers the money they needed. They required a 35 percent down payment, with the rest of the cost being paid over a 12 month period.
Henry Ford was opposed to this idea, and offered an old-fashioned layaway plan called the “Weekly Payment Plan”. Since Americans wanted more expensive cars on credit, this plan failed. By 1928, Ford Motor Company also offered auto loans. The market was changing.
Throughout the 1910s, banks issued loans to consumers looking to buy a car. Families began making monthly payments of $10-20 dollars per month. This had a profound impact on consumer spending. Families often sacrificed other necessities in order to continue making car loan payments. Concerned about the potential for predatory loan practices, the Federal Reserve warned banks to only offer financing for customers who needed an automobile for work-related purposes.
This did not deter consumers. As a result of the introduction of auto financing, cars became attainable to more families than ever before. By 1930, over 50% of households in America owned an automobile. It was no longer considered a novelty, but an essential tool for daily life.
Crash and Burn
The following decade was overshadowed by the Great Depression. The crash resulted in a huge loss of wealth. Some historians blame the consumer culture of the 20s for this financial collapse, and the automotive industry played a major role. Families had to restrict their spending, which meant car sales suffered drastically. Compounding this problem, existing loans were commonly defaulted on.
People became anxious about whether or not their cash would be available to them in times of need. Many Americans immediately sought to withdraw all money from their accounts, and banks suffered. Defaulted loans, in addition to other factors, ensured that banks were not able to fulfill all of these requests. These factors contributed to the shutting down of over 7,000 banks nationwide and lost wealth for those unable to withdraw their money.
Car sales were down. Consumers were not interested in pursuing financing. Unemployment rates skyrocketed to unprecedented levels.
How were these issues resolved? The end of World War II brought thousands of Americans out of employment and into roles in the military. While this technically decreased the unemployment rate, it bolstered the national debt. Economic relief came as a result of freer markets and lower taxes in the mid 40s. Spending increased and customers once again sought auto financing to remain competitive in the job market of a recovering economy.
The subsequent years were relatively stable. One trend that changed the notion of the American road trip was the recreational vehicle. While they have seen a resurgence in popularity in recent years, RVs were introduced in the 1950s. RVs were quite expensive at the time, and customers often had to seek financing in order to afford them.
The mid-1950s saw several events that would forever change automotive history. In 1954, Vehicle Identification Numbers (VINs) were introduced — and creditors began requesting VINs before issuing any auto loans. In 1956, the Federal-Aid Highway Act was passed. Over 40,000 miles of roads were to be build to connect every major population center in the US. While the interstate was not actually completed until 1990(!), the improved infrastructure enticed more households to invest in an automobile throughout the decades of construction.
The same year this act was passed, the FICO score was created by Fair, Isaac and Company (today named the Fair Isaac Corporation) — a data analytics company. The FICO score was a credit scoring idea that banks and retailers across the United States could use to determine the risk of making loans to specific customers. The idea caught on. In 1970, the Fair Credit Reporting Act was passed, regulating data collection and improving transparency of the process for consumers.
Auto Financing Today
Car financing became increasingly popular as car prices have risen. Since 1965, automobiles have grown more and more expensive, keeping inflation in mind. On the positive side, car loan interest rates have steadily declined in that same timeframe. While the average car loan interest rate stood at a preposterous 16% in the early 1980s, it has since fallen to 4.35%. These facts have led to an increased number of auto loans throughout the years.
Like every other industry, the internet has also had an impact on auto financing. Today, more car buyers are using the internet to make decisions on purchases. Accordingly, many car loan providers have taken business online. Online car loans can be quick and convenient, but they can also be dangerous. Besides the problem of predatory loans, submitting information for a credit approval online leaves consumers open to fraud. Using information that consumers submit online, cybercriminals are able to commit identity theft.
The way credit is calculated has also evolved over the years. Your credit score is the summation of your payment history, credit use, length of credit history, new credit, and derogatory marks. This gives lenders a strong sense of whether or not a consumer might default on a loan, and prevents creditors from making bad decisions. Several organizations today offer free credit reports, though these can vary due to different algorithms.
Throughout history, car financing has opened the doors to new opportunities for households across the nation. As car prices have risen, interest rates have decreased. Despite the perception that loans are a deceptive or predatory practice, it has usually been a consumer-focused industry. Auto financing has kept families across the nation on the road for nearly a century.