Credit unions that offer subprime auto loans know the practice can be both rewarding and challenging.
Lending consultants offer these seven pointers on creating a thriving subprime auto loan program:
1 Stick to direct lending. Reach out to the borrowers you know—current members. They’ll be more loyal and apt to pay you back than consumers coming in off the car lot.
“Hundreds of millions of dollars have been charged off in the industry because credit unions started doing nonprime loans on the indirect side,” says Brett Christensen, owner of CU Lending Advice.
2 Build a performing loan during the loan interview. That means getting the borrower into the right car for the right loan amount at a comfortable monthly payment, Christensen explains.
“Don’t set people up to fail,” he says. “Sell credit insurance products so when they have bumps in their lives, they’re covered. And put them on automatic payment instead of using a coupon.”
3 Nail the underwriting. “There are lower-risk 520 [credit scores] and higher-risk 520s,” Christensen says. “The underwriter has to figure out which to approve and which to deny.”
Dig deep to evaluate. Get answers to questions such as, what’s the quality of the applicant’s job? What kind of account relationship does he or she have with your credit union? Is the borrower willing to make payments through automatic deduction?
4 Don’t get hung up on the vehicle itself. “Loan-to-value is not a predictor of the likelihood of loan repayment,” says Paul Kirkbride, senior vice president for credit union solutions at CU Direct Corp. Set your sights on affordability for the individual borrower.
That’s a good general lending principle, Kirkbride says, “but it’s even more important with this higher-risk group. Remember, cars don’t make payments; people do.”
5 Price correctly. Credit unions sometimes balk at pricing nonprime loans high enough, Christensen observes. But these loans are riskier and more labor intensive all along, from underwriting through collections. “You have to price these loans to cover your expenses and losses,” he says.
6 Prepare on the back end. Give thought to collections up front, Kirkbride advises. Monitoring nonprime auto loans is critical.
Follow up on delinquencies or other triggers quickly to minimize losses. “Ask yourself if you can efficiently collect on these loans now,” he says, “rather than scrambling to add more bodies to your collections staff later.”
7 Be realistic and manage your expectations. Properly reserve for nonprime loans and set prudent portfolio and/or net worth limits, Kirkbride advises.
You will incur losses, and you may make mistakes at first, he adds. If you’re not prepared for that, you can succumb “to sort of a knee-jerk reaction to pull out of nonprime lending completely,” he says, “rather than making needed adjustments.”