The Promise and Peril of Subprime Lending

Embrace C-, D-, E-tier members—to grow loans and to serve a greater swath of members.

January 1, 2013

Credit unions can boost their bottom lines and serve the growing number of credit-impaired consumers by cautiously entering into the subprime arena, says Brett Christensen, owner of CU Lending Advice and former vice president of lending and sales at Clark County Credit Union in Las Vegas.

He says credit unions are “stabbing each other in the back” with low-rate auto loans aimed at top-tier members.

Christensen cites a credit union client that recently made a $20,000 car loan with a 30-month term and a 1.3% interest rate—and stands to make only $341 in interest. “They’re giving away money.”

In contrast, another client recently made a $16,000 auto loan with a 72-month term at a 15.9% interest rate. This credit-impaired member will pay $9,000 in interest—and get out from under a 22.9% rate at a bank.

“You have to do the math at some point,” says Christensen, who believes credit unions should embrace C-, D-, E-tier members—not only to grow loans and income, but to serve a greater swath of members.

“These members have the greatest need and the fewest options,” he says. “And if you help D- and E-paper members, they will be very loyal. Can the same be said of A-paper members?”

While there’s certainly promise in subprime lending, there’s also peril. Christensen’s advice:

  • Go direct only. Don’t stray into indirect subprime auto loans, where the credit union typically has no established relationship with the member.
  • Start with secured loans. Christensen says consumers’ top repayment priority has shifted from mortgages to auto loans. “It makes no sense to make $1,000 or $2,000 signature loans to D and E borrowers,” he says, “but not make a loan for a car that takes these members to work and that’s secured. It’s backwards.”
  • Price loans correctly. Taking on additional risk justifies earning a greater reward.
  • Distinguish between high- and low-risk members in every credit tier. A credit-impaired member with an established employment record and a good repayment history is a far better risk than someone who’s new on the job and has no repayment history, even if they have the same credit score.
  • Collect aggressively. This starts during the loan interview, Christensen says, with a “firm close.” This is where the credit union outlines actions it will take if a loan payment is late.
  • Require a down payment so the member “has some skin in the game,” he says. “Money down isn’t a guarantee—but cash spells commitment.”
  • Don’t finance vehicles that are more than six model years old or that have more than 85,000 miles. Doing so simply sets up credit-impaired members for failure.
  • Build credit life and disability, mechanical breakdown, and guaranteed asset protection insurance into the loans.