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Subprime Originations Roar Back, Protect Yourself

Over the past few years, concern grew that the auto industry was driving the next credit crisis with ever-increasing subprime loans.

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Over the past few years, concern grew that the auto industry was driving the next credit crisis with ever-increasing subprime loans.

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Then, subprime lending cooled off for a bit and the negative headlines seemed to melt away. Troubles with subprime loans seemed to have been forgotten.

But in the third quarter of this year, subprime originations roared back, according to the Federal Reserve Bank of New York’s “Household Debt and Credit Report.” They rose nearly $33 billion, a 10-percent gain compared to the previous year, which was the first year-over-year gain since the second quarter of 2016.

Delinquencies continue to edge up as well. According to the New York Fed, the number of borrowers delinquent 90 or more days increased to 4.3 percent. In 2005, that figure was at 1.99 percent.

While talk of an impending credit crisis hasn’t reared up again, that doesn’t mean dealers should be resting on their laurels. These types of numbers should scare dealers into ensuring that they are putting buyers into cars they can afford.

Lenders certainly have been taking steps to make sure buyers can afford the cars. Lender agreements have been changing for the past couple of years, according to Wolf Richter, CEO and founder of the business and financial information website Wolfstreet.com.

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The Fed’s monthly “Senior Loan Officer Opinion Survey” has shown that banks have slowly tightened lending standards for subprime auto loans. The latest survey in October indicatedsignificant and moderate net fractions of banks reported that they were less likely to approve credit card and auto loan applications, respectively, from borrowers with FICO scores of 620.”

Through greater use of technology, lenders also have gotten a lot smarter about how and when to approve loans to subprime borrowers. They have been increasingly using what’s called “machine learning” in their underwriting. Basically, they use complex algorithms to create models that increase the odds that they make the correct decision in lending to a subprime borrower and reduce the risk of repossession.

Dealers aren’t going to fool these models. Conscientious dealers make sure that their repossession risk is lower by validating income of buyers and selling them a car that fits the customer’s budget.

There are plenty who won’t and think they can fool the lenders. They inflate incomes and power book vehicles to put the deal together. They do it without much thought. Little do they realize that the dealer is on the hook and will have to pay full recourse if the vehicle is repossessed by the bank and the income is misstated.

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Dealers could pull in the technology for themselves. Look for partners that can make validating income easier and more accurate. There are options available that give dealers and lenders an automated way to do traditional asset and net income verification. This process avoids stips and will help drastically cut down on CIT (Contract-In-Transit), which can cost the dealer up to an average of $32 in holding costs alone.

The F&I manager won’t have to spend time chasing stips for funding or re-contracting caused by inaccurate information. Every time a customer has to be re-contracted, the dealer stands the chance that back-end products get cut. The customer simply doesn’t want to increase the payment in lieu of taking advantage of the service contract or ancillary products.

This new process may be challenging for some F&I people to embrace, especially those who see the advantage of collecting stips directly from the customer, even if it means they could have been altered to obtain bank approval.

Dealers who aren’t keen on doing subprime loans to begin with may appreciate this alternative. It removes the guesswork. Once the customer passes the inspection, the financing is approved and the dealer doesn’t have to be concerned about funding delays.

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Subprime deals tend to get squirrelly before they get into the F&I office. Training sales managers on subprime desking procedures is an essential part of ensuring that the customer is put on a car that fits within their budget. The F&I manager should meet the customer earlier in the process, conduct a credit interview, find out what’s happened, what’s changed and why it won’t happen again.

The idea is to get the story behind the slow pay history for the lender. Not all lenders buy a FICO score. The story may even get the deal approved. They want to hear the story. Always validate proof of income. Get a copy of the customer’s paycheck and proof of residence.

Also, be prepared for the bank to interview the customer. So, make sure you’ve gathered all of the facts. Make it a point to properly book out the vehicle. Don’t leave anything to chance.

Today, many customers now look to not only shop for vehicles online but also finance online. Giving the customer the option to self-desk online at the dealer website or onsite helps ensure the customer ends up on the right vehicle the first time out.

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Self-desking allows the customer the flexibility to obtain pre-approval and determine the payments based on credit criteria prior to coming into the dealership. It avoids the customer landing on a vehicle they won’t be able to qualify for based on credit or budget. It will dramatically increase profits and speed up the delivery process. Subprime customers don’t want to be dragged through an all-day process at the dealership when buying a car.

A subprime customer can be the most loyal customer you ever have. The customer will be back to buy another vehicle at your dealership down the road if they are treated well and not put on a car they can’t afford and ultimately end up giving back.


Click here to view more solutions from Rebecca Chernek and Chernek Consulting, LLC.

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