Razor-thin margins on A-paper auto loans and the growing number of consumers with impaired credit records mean credit unions should look closely at entering into the subprime arena, a lending consultant told attendees of the CUNA Lending Council Conference in Miami.
Credit unions are “stabbing each other in the back” with low-rate auto loans aimed at top-tier members, 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 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. The 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-tiered 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?”
In addition, an aging population will force credit unions to “buy deeper into the pie” to maintain loan growth, Christensen says, and aggressive dealer financing will cause credit unions to lose auto loans from the most creditworthy members.
“And,” he adds, “you can actually make money on D- and E-paper auto loans.”
Certain rules apply, however, when lending to members with damaged credit. They include:
►Go direct only. Don’t stray into indirect subprime auto loans, where the credit union typically has no established relationship with the member.
“Your credit union doesn’t mean a thing to strangers,” Christensen warns, citing a New York credit union that experienced a 10% charge-off ratio among its indirect subprime auto loans.
►Start with secured loans, and then ease into unsecured. “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.”
Consumers’ top repayment priority has shifted from mortgages to auto loans, TransUnion reports. “Auto loans are the No. 1 priority loan for consumers,” Christensen says.
►Price loans correctly. Taking on additional risk allows credit unions to earn 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,” where the credit union outlines actions it will take if a loan payment is late.
One of Christensen’s clients, for example, explains that it will call a subprime member who is one day late on a loan payment and ask for the payment to be made by 5 p.m. that day. If the member hasn’t made a payment by the next morning, the credit union repeats its request—and begins the repossession process if the member fails to deliver.
“That’s a firm close,” Christensen says. “If you wait 25 days to contact a delinquent subprime member, you’ve waited 23 days too long.”
►Require a down payment so the member “has some skin in the game,” he says. “Cash 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. “If a car doesn’t run, D and E borrowers won’t make the payment.”
►Build credit life and disability, mechanical breakdown, and GAP insurance into the loan. Subprime members generally don’t have the resources to make major vehicle repairs.
►Eliminate restrictive policies that affect members’ ability to repay their loans. Limiting subprime loan terms to 60 months, for example, often makes members’ payments too high.