Over the years, we’ve watched the manual underwriting process evolve into an automated one, with loan decisions generated in split seconds. The current market turmoil might upend that methodology, though, as artificially low credit scores keep potential car buyers out of the market.
In a nutshell, here’s the premise: Increasingly, there are consumers who used to be model borrowers, repaying their loans on time, month after month. They lose their jobs — and their ability to make those monthly payments. They either miss a few payments until they get back on their feet, or have their vehicles repossessed. A few months later, they secure new jobs, potentially at lower pay grades. But when they go to apply for vehicle loans, their credit scores are hammered. What may have been close to 800 credit scores are now 580s or 600s.
Multiply that situation by the number of newly unemployed in the U.S. (524,000 in December alone, and 2.6 million for all of 2008), and we could be in for an even longer slowdown in the auto finance sector.
The way I see it, lenders need to delve deeper into the details to determine the root of lower credit scores. Are they largely one-time occurrences that walloped consumers’ credit? I’m not suggesting that we revert back to manual underwriting processes, but we should certainly leverage the tremendous technology available to better identify these victims of circumstance.
If not, lenders will pass up some great borrowers who simply hit on hard times. And borrowers will have to wait longer to secure credit, which will significantly slow the industry’s rebound.
Unfortunately, we do not have a crystal ball to tell us if someone will become unemployed or have their wages lowered. Manual underwriting can determine if the current credit problems were caused by someone loosing their job but you cannot price for the unknown unless you forecast historically how unemployment rates and default rates coincide and develop your pricing accordingly for what may happen. An unemployment insurance is a good idea but I am thinking that the pricing would be very high right now with the unemployment rates being predicted to go to double digits. I also agree that there are tools that can be used to perfect data for current information, like a Lexis Nexis product, but not sure it will even help enough in these economic time. A combination of all these ideas could surely help.
A funny thing happened on the way to the automotive retail sales implosion. Banks and finance companies became so automated that the human element was eliminated. The tragedy of the story is car dealers were happy to join in on the party and drink the credit score kool-aid with the banks and finance companies. The insuing meltdown of dealer relationships with customers and lenders became instaneous. The GIGO concept was endorsed by dealers that submitted eroneous information and for lenders that used credit scoring systems to decision applications. Too many people were buying cars they couldn’t afford or did not qualify to buy.
The finance industry lost experience credit analyst and replaced them with people that had the ability to “push a button” for a decision only after being prompted by a computer. I predicted this day of reckoning would come ten years ago not because I’m a prophet, but rather I’ve been in the finance business long enough to know that credit scores do not make car payments!!
Only when this industry wakes up and return to a common sense way of doing business will we see a recovery. And yes, thats “change” we can only hope will happen without the government’s help.
Thanks, everyone, for your input. It’s been really enlightening.
I just wanted to comment on a few things that have been mentioned so far:
My reason for proposing that the credit scores are “artificially” low is because these borrowers we’re talking about are not typical nonprime or subprime borrowers. In other words, they’ve made their monthly payments perfectly for years (or even decades), and they will return to that perfect payment record as soon as their jobs are restored. At this point, though, the economy is in such a severe funk, that even people who *have* saved might not be able to avoid repossession. For people who have saved, they might only have enough of a cushion to pay all their monthly bills — mortgage, car, utilities, groceries, etc. — for three months, not the six or nine they might be out of work these days. And what I’m saying is that once that job (or a decently comparable one) is restored, the credit score will not reflect that. It would be a 550 (for example), when in reality it should be much closer to the original 720. In other words, the job loss and its resulting delinquency will scar the consumers’ credit standing unjustifiably —because as soon as the job is restored, so will the on-time monthly payments.
Another issue: As I mentioned in the original post, I don’t think that we can revert back to manual underwriting on any kind of large scale. But certainly those lenders who manually review every single application will stand to gain from this crop of consumers that has been labeled 550s and will ultimately pay like 720s.
One of the things I’m getting at is whether we’ll see lenders refine their methodology for reviewing credit scores or weighting them. Will they pay more attention to consumers’ savings? Or maybe, as John Paulsen suggested, we’ll see lenders offer some kind of unemployment insurance…
I would agree with the comments by Jonathon Levin – credit score should not be the only piece of information that is looked at when determining whether to approve or decline a customer. Character of the customer, Capacity to pay, Collateral and Credit should all be considerations. And there are still lenders out there that rely on relationships that have been established and maintained with their dealer partners over many years that allow them to give special consideration once they know ‘the story’ associated with the particular customer in question. When circumstances result in a good customers credit score eroding, that shouldn’t be the end of the line. There might still be a deal there if you do enough digging.
On a separate note, the prospect of an unemployment insurance product is intriguing! I have no idea if that type of product would be cost-prohibitive as suggested by other posters but it’s an interesting solution to the problem.