Over the past several months, a lot of press has been dedicated to the resurgence of subprime auto lending and fear of an impending subprime “bubble.” While it is true that subprime lending volumes are up, this does not necessarily signal that the market is headed for a crash like the mortgage industry suffered.
The nonprime and subprime auto lending categories have been strong segments in the auto finance market for decades, and there is no reason to believe that will change in the foreseeable future. However, there is a need to look beyond the doomsday – and decidedly one-sided – messaging contained in the mass media and proactively address some of the ramifications and fallout.
A lot of the negative press has centered on stories of unscrupulous lenders who employ fear tactics and take advantage of customers with lower incomes or tarnished credit. It’s easy to see why the general public believes that this approach is the industry norm, as opposed to isolated incidents. Unfortunately, the broad inference in these stories is perpetuating misconceptions of the subprime lending industry and the lenders involved. The resulting concerns overshadow the truth about the opportunities afforded to customers that fall within this market segment.
For every negative story, there are hundreds of other examples where a borrower who lost everything due to unexpected or tragic events such as divorce, illness or family death was able to persevere with the help of a lender that was willing to take the risk and approve a car loan for that “subprime” customer. Unfortunately, these stories never seem to make it into the overwhelming number of articles written about the industry.
Lenders seeking success in subprime auto lending must be committed to sound lending and operational practices but must also formulate stronger customer service and compliance strategies. There are several considerations – and concerns – for lenders involved in this space.
A major component of subprime lending is risk-based pricing. Simply put, in the absence of usury limits or caps on finance charges and fees, there is a corresponding rate and fee for any contract that allows a lender to appropriately lend to a portfolio of customers and cover the associated risk. While risk-based pricing allows a lender to extend credit to a broad spectrum of consumers, it is viewed by some as price gouging, or a stealthy way to charge exorbitant interest rates to customers who simply cannot afford them.
The reality is that the interest rate does not make a loan unaffordable, too much payment does. A universal truth in lending – whether the loan is prime, nonprime or subprime – is that a consumer who cannot afford a payment will eventually stop paying, either by finding a way of paying off the loan or by defaulting. The last thing a lender wants is for customers to default. It is very rare, even if a vehicle is repossessed and sold, for a lender to recoup the balance and revenue if they have to go to recovery. Because of this, lenders try to structure deals in such a way that the customer can afford the payment.
Understanding the Payment Call
The standard credit decision process in the subprime market is the payment call. This is an approval to extend credit to the customer for any eligible vehicle up to a maximum payment and advance. The payment portion to insure the customer can afford the payment and the maximum advance, or Loan to Value (LTV), is a way to limit liability on the vehicle, which is a depreciating asset.
All too often, this is perceived as a way for the dealer to strong-arm customers into vehicles they do not want or that the dealer has been hanging onto for months. However, most lenders want to give the dealer and customer flexibility to choose the most-suitable, most-eligible vehicle for their circumstance without having to apply and reapply for credit for multiple vehicles. The majority of lenders have strict guidelines on what types of vehicles are considered eligible. For instance, there could be age or mileage thresholds in order to reduce the likelihood of problems with the vehicle during the term of the contract. One of the biggest concerns is the vehicle developing a major mechanical problem that the customer can’t afford or is unwilling to fix, opting instead to walk away from the vehicle – and the credit obligation.
How customers are treated is also a critical factor in how well a lender succeeds in the subprime segment. This applies to both the purchase and servicing aspects of the lending lifecycle. Most borrowers need to feel that they got the right vehicle at a fair price and for affordable terms. If the customer feels they got a fair deal, their satisfaction with the vehicle and the purchase experience tends to make them more likely to make their payments. If the customer feels that the dealer took advantage of them, there is an inherent risk that they will transfer that dissatisfaction from the dealer to the lender as the account holder, which could lead to an increased risk of default or prepayment.
Likewise, inattentive customer service agents or overly zealous collectors can leave a bad taste in the customer’s mouth. The Consumer Financial Protection Bureau (CFPB) tracks customer complaints and takes them into account as one of the factors in determining whether to investigate a lender. Although it’s impossible to make all customers happy all the time, having consumer-facing employees treat customers with respect during every interaction will go a long way towards creating goodwill and customer loyalty.
It is increasingly important for lenders to have policies and procedures in place and to provide ongoing staff training related to consumer expectations and customer service encounters. There are numerous technology offerings available to help a lender’s operations group monitor how their agents are performing and identify potential issues that need to be addressed before they escalate.
Use of GPS Locators and Starter Interrupters
Some of the biggest concerns in subprime lending have to do with the use of GPS locators and starter interrupter devices. Skip tracing and locating vehicles for repossession can be a very costly and time consuming process. If the vehicle cannot be located, lenders lose the entire outstanding balance plus any charges incurred while trying to find the vehicle. Combatting this with GPS locators and starter interrupters has become a staple for subprime lenders.
While using these devices is a sound operational practice, there are conflicting opinions about how they should be deployed, and some misconceptions about how they operate (such as the idea that a lender can cause accidents by disabling a vehicle while it is in motion. Lenders should establish strict policies that insure that the devices are installed correctly and that their use is within state and federal regulations and guidelines. In addition, employees and customers both need to understand how they work and when they will be employed.
Winning the Hearts and Minds of Consumers
With today’s increased scrutiny on lender practices in the subprime market, lenders need to be aware of public perception and how it impacts their business. This means following the media coverage, monitoring CFPB complaints, and reviewing what’s being said in social media channels to understand public perception about their business. Success in subprime is no longer predicated solely on solid risk management, strong credit policies and effective operations. Compliance and winning the hearts and minds of consumers can have equal impact. Lenders that have sound policies and procedures, solid training and good monitoring tools in place can help ensure that misperception does not become reality.
Scott Hendriks is senior product manager, Lending Solutions, with Fiserv Automotive Solutions.