Sunday, November 29, 2015

The Risks and Rewards of Subprime Auto Lending

By Steve Hoke
NOTE: This story originally published in Credit Union Times on November 18

Owning a reliable vehicle is a basic necessity for most Americans and a concrete representation of their financial well-being. The Consumer Financial Protection Bureau identifies four elements of financial well-being:
  1. Control over routine finances;
  2. Capacity to absorb a financial shock;
  3. Ability to stay on track to meet financial goals; and
  4. Freedom to make choices that allow one to enjoy life.
Good jobs paying good wages allow people to achieve those aims. And in many cases, access to fairly priced car loans makes getting to and from those jobs possible. Credit unions can help members in subprime credit tiers take giant steps toward achieving financial well-being.

Especially for members with once-prime credit who were bumped into subprime territory by the Great Recession, qualifying for an affordable vehicle loan offers the opportunity to prove that their repayment habits have changed. 
At the same time, serving the subprime auto lending market can provide credit unions with a reliable revenue stream when that portfolio is managed carefully. 

Consider these calculations: The return on a subprime auto loan at 14.15% over a full term of 60 months is $6,011, while the same loan at a super prime rate of 3.53% generates $1,385. 
If a member with a subprime loan defaults, the credit union would need to make around 2.5 additional loans at the same rate to recover the lost principal, compared to 11 loans at the super prime rate.

Several strategies have been demonstrated to help credit unions lower the risks and enhance the rewards of subprime auto lending:
  • Reward members for prompt repayment. Structuring a credit-builder auto loan option that lowers interest rates as members make their payments on schedule provides the tandem incentives of saving money and increasing credit scores.
  • Mitigate risk through insurance products that help protect collateral or loan repayment in the event that the credit union repossesses a damaged vehicle or an uninsured borrower’s vehicle is damaged; a borrower stops making loan payments and neither the borrower nor the vehicle can be located; or a borrower can no longer repay a loan.The costs of some of these products can be integrated into loan rates or passed directly on to borrowers.
  • Provide more verified information for underwriting. New technology tools can facilitate real-time income and employment verification. In a study by Equifax, borrowers who overstated their income on an auto loan application by more than 15% were more than three times as likely to be seriously delinquent (60 or more days past due on their loans) than those who did not inflate their income. Obtaining salary documentation directly from employers also relieves members of the hassle of providing that information, and can speed up loan closing and funding.
  • Use direct marketing to recapture existing loans. Ent Federal Credit Union in Colorado Springs, Colo., mined automated clearinghouse data to identify members with improving credit scores who were making payments to subprime auto lenders. The $4 billion asset credit union generated $2 million in recaptured auto loans and was honored with a 2015 Excellence in Lending Award, sponsored by CUNA Mutual Group and the CUNA Lending Council. 

    Along the same lines, CUNA Mutual Group’s Auto Loan Recapture® program identifies members who’ve recently financed an auto purchase with another lender. Credit unions using this tool can set credit score criteria for members who receive personalized refinancing offers.
  • Leverage technology to increase direct loan activity. The AskAuto® app is an example of engaging members looking for a different car-buying experience. They can conveniently research multiple vehicles, validate prices, and apply for auto loans from your credit union using their smartphones.
It’s no coincidence that the employment picture and auto market are simultaneously rebounding, and 2016 could be another banner year. In fact, the National Automobile Dealers Association forecasts record sales in the coming year. Employing strategies like these can help your credit union increase its share of the auto loan market—and help members across the credit spectrum enhance their financial well-being.

 is director of loan growth products for CUNA Mutual Group. Contact him at 608-665-7178.