Key Facts:
The reconciliation package contains a provision that would allow taxpayers of up to a certain income level to deduct as much as $10,000 in loan interest payments.
While intended to provide relief to taxpayers, it would likely exacerbate the problem of rising loan delinquency rates by exerting further demand pressure on the auto loan market.
A better solution would be to reward taxpayers for making responsible financial decisions by capping the term and monthly payments on loans that are eligible for the deduction.
While student loans have been the focus of discussions of debt relief, cars tend to drive under the radar. At $1.64 trillion in total, auto loans are a greater source of debt among the American public than either student loans or credit cards. What’s more, this huge amount of liability represents a brewing crisis that may trigger deja vu — 60+ day auto loan delinquencies reached record highs among subprime borrowers back in January of this year.
At first glance, the provision in the One Big Beautiful Bill Act (OBBBA) that would allow taxpayers to deduct interest payments on car loans may appear to be a logical way to help out Americans who are struggling to manage their auto loan payments. But providing a tax break for something tends to lead to more of that thing — and more subprime auto loan debt is the last thing that is needed.
Deductible Auto Loans in the OBBBA
The relevant provision in the OBBBA would allow deductibility of up to $10,000 in interest on auto loans from 2025 through 2028. The deduction would phase out beginning at $100,000 in AGI for single filers and $200,000 in AGI for married filers — for every additional $1,000 in AGI over the above thresholds, taxpayers would lose the ability to deduct $200 in auto loan interest. Lease financing would not be eligible.
While the phaseout is intended to ensure that relief is targeted to those who need it, the effect on incentives is entirely backwards. Basic economics tells us that making auto loans less expensive for poorer Americans (by allowing them to deduct interest expenses on their tax returns) will encourage more loans among the segment of the population that is more likely to be subprime borrowers — even though subprime borrowers are delinquent at 17 times the rate of prime borrowers. What’s more, by juicing up demand for loans, interest rates are likely to increase for all borrowers.
In 2024, more than 27% of new car loans were either subprime or midprime. Should those numbers tick up further (or, perhaps more importantly, should delinquency rates among subprime borrowers rise), that could lead to real problems in the lending market.
Another factor to consider is the impact of tariffs. NTU has estimated that tariffs could increase the price of new, imported automobiles by an average of $6,532. Domestic car prices will be affected as well as competition from foreign automakers is artificially restricted. Higher car prices means that cash-poor consumers will need to take out bigger loans to pay for them — a demand trigger that likewise would lead to higher interest rates.
In short, the result will not be more affordable loans, but more auto debt. Since the demand incentive will be disproportionately distributed towards subprime borrowers, the new debt will be disproportionately concentrated among subprime borrowers. It is a recipe not for solving the problem of bloated auto loan debt, but magnifying it.
The other real problem is that large auto loans are generally not a smart financial decision. With mortgages, the underlying asset is hopefully appreciating in value over time, while student loans finance education that increases one’s wage-earning potential. Automobiles, on the other hand, are depreciating assets, becoming less valuable from the moment they are driven off the car dealership lot.
Of course, that does not mean that auto loans are necessarily avoidable. Americans need cars to get to work and take care of their families. What is avoidable is taking out large loans for expensive vehicles that one cannot afford. Yet the average monthly auto loan on new vehicles for subprime borrowers is $759 with a 73.5-month term, while the average loan amount in this borrowing tier is $38,688. Loans on used vehicles for subprime borrowers are not much better, averaging $539 a month over a 66-month term, with a total principal of $22,051. Six years is a painfully long amount of time to be stuck paying off a significant loan for an asset that will be worth a fraction of its original value by the time the loan is paid off.
Potential Solutions
The best way to help borrowers with car affordability is through lower prices. Tariffs on automobiles, as well as automobile inputs such as steel and aluminum, militate directly against this goal. Relaxing import restrictions on these goods and materials would make cars less expensive and limit the size of loans cash-poor borrowers would need to take out to afford vehicles.
But assuming that members of Congress are determined to address this issue through the tax bill, targeting relief solely based on AGI is not the best way to do so. As noted above, this would have the effect not of making car loans more affordable to less wealthy Americans, but of encouraging more demand for auto loans among a population that is disproportionately credit-risky.
A better way would be not to encourage borrowing of any sort so long as the applicant is below an AGI threshold, but to encourage responsible borrowing.
One way to do this would be to cap the size of the loan that is eligible for the tax break. The existing proposal already caps the amount of interest that is deductible in a year, but $10,000 in interest payments in a single year is not much of a cap. Further, taxpayers can have auto loan interest payments above the cap, but still receive the tax break for the first $10,000 in interest.
A more elegant solution would be to add a limit not only on the amount of interest that is deductible, but also on the term of the loan and monthly payment for the taxpayer to be eligible. Taxpayers most in need of a tax break on loan interest should not be taking out massive, six-year loans on new vehicles. On the other hand, taxpayers who can afford to take out these types of mega-auto loans do not need the tax break.
Doing so would also realign the incentives in this provision from bad to good. Rather than putting further pressure on low-income, credit-risky taxpayers to take out more extensive auto loans, it would discourage them from taking out irresponsible loans while simultaneously providing tax relief to taxpayers who take out loans that are more affordable.
Lastly, capping interest deductibility on the most exorbitant loans would reduce foregone revenue. CBO currently estimates that the loan deductibility proposal would reduce revenue by $57.7 billion between 2025-2028. Limiting the revenue impact would allow for either less overall deficit impact or further tax relief elsewhere.
Conclusion
While intended to help taxpayers with one of the biggest drivers of debt, the auto loan proposal as it currently stands is more likely to incentivize taxpayers to take out more bad loans and put themselves in greater financial holes — holes that they could well still be in by the time the deductibility runs out in 2028.
However, with some minor fixes, Congress could both ensure that the relief is better-targeted towards those who need it and ensure that it is incentivizing responsible borrowing practices. If Congress wants to provide taxpayers with help affording automobiles, it should make sure that it is helping those who need it in a way that truly does help them.