Making loans to subprime, or nonprime, borrowers is risky business. But if properly implemented and controlled, these loan can be an acceptable complement to credit unions’ loan portfolios—and a vehicle to meet members’ needs.
That’s according to “Non-Prime Auto Loans,” a report from the National Credit Union Foundation.
The report outlines several steps credit unions can take to mitigate subprime lending risk:
1. Use a co-signer. Doing so is generally acceptable for a borrower with limited credit, but be wary about using a co-signer who has poor credit. Parents typically are acceptable cosigners, as long as their credit is good.
2. Encourage the borrower to use automated payments from checking or savings, or direct deposit. These loans perform better than payments made via a statement or coupon book.
3. Provide financial education. Some credit unions require financial education as part of their subprime auto loan programs to educate borrowers about their credit scores and how to improve them, and to help them establish a workable budget that includes both the car payment and other costs of car ownership.
Another way to encourage members to complete some form of financial counseling or education is to reduce their loan rates following completion. There are variety of programs credit unions can make available to members, including Greenpath Debt Solutions, a CUNA Strategic Services alliance provider.
4. Require auto starter-interrupter devices. A starter interrupter device disables the car from starting when borrowers miss a monthly car loan payment. Some credit unions require installment of the device for high-risk borrowers.
Such devices also serve as a reminder to borrowers when payments are due. The device may chirp or flash a light when the car is started to warn drivers that a payment is coming up or is overdue.
Credit unions have control over the parameters of the device, and can decide how delinquent a borrower can be before the car shuts down. The device will not shut the car down while it is being driven, but prevents it from starting when the delinquent threshold has been reached.
5. Offer incentives for timely payments. Credit unions can reward borrowers with lower interest rates or other incentives after timely payments of 12 to 24 months. Such incentives create opportunities to educate members about the importance of on-time payments and to cross sell the benefits of direct deposit or auto pay.
6. Employ a “firm close” and stay in touch. A loan well closed is half collected, says a wise lender. Use the loan closing to connect with your nonprime borrowers and impress upon them the “leap of faith” the credit union is making in them.
This entails reviewing all aspects of the loan—payment amount, due date, interest rate—and communicating the importance of staying in touch if the member experiences unanticipated problems.
Some credit unions contact the borrower seven to 10 days after the loan closing to review and reinforce aspects of the loan and application once again.
7. Have lower loan-to-value (LTV) requirements for nonprime borrowers. The higher the risk, the lower the LTV. But remember: a bad loan is a bad loan regardless of LTV.
8. Mitigate risk with insurance products, such as credit life and disability, debt cancelation, guaranteed asset protection, and mechanical breakdown protection.
9. Implement aggressive collection efforts. Begin collection efforts early. Nonprime loans should have a special collateral code or some system of identification so collection can begin early if needed.
Some credit unions use an auto dialer to remind nonprime borrowers that their payments are due in one or two day, while others call with a friendly reminder when the loan is one day late.
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