NCUF Report Shows How Credit Unions Help Car Buyers Avoid Predatory Loans

Free Steer Clear Report Presents 7 Lessons from Credit Unions Making Sustainable Used Auto Loans to Non-Prime Borrowers

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If credit unions learn from seven lessons in a new research report published by the National Credit Union Foundation (NCUF), more credit unions can offer financially viable programs to help car buyers “steer clear” of predatory auto loans.

Steer Clear: How Credit Unions Help Car Buyers Avoid Predatory Loans, demonstrates how credit unions could gain a sustainable share of the “non-prime” market, where 8 million used cars are sold each year to borrowers with less than prime credit scores.

The 60-page Steer Clear report is available free of charge.

Just click the icon on the right to open or save the entire Steer Clear report.

Market Opportunities

More than 88% of Americans need a car to drive to work. Affordable transportation is even more critical for workers with low incomes. Yet the non-prime auto loan market is currently dominated by sub-prime lenders (60% market share) and banks (30% market share) that charge much higher interest rates than credit unions.

“Non-prime auto lending represents a substantial opportunity for credit unions to expand their markets, build net income, and attract new loyal members by giving them a substantially better deal,” observes report author Bill Myers, Field Coach for NCUF’s REAL Solutions program and Senior Fellow at The Aspen Institute.

The report’s seven lessons are based on experiences from over 250 credit union lenders who responded to a survey commissioned by NCUF, as well as Myers’ follow-up research on best practices from credit unions making “large and sustainable inroads” into non-prime auto lending.

“Credit unions are able to successfully enter the non-prime auto lending market by incorporating these lessons into loan programs designed specifically to meet the needs of emerging markets,” Myers explains.

Lesson 1: Non-prime used auto lending is a financially viable line of business.

Credit unions making non-prime used auto loans find higher net margins boost their bottom lines. Even with higher costs for originating and servicing loans to borrowers with the lowest credit scores (E-paper), credit unions earn more net income on E-paper loans than on loans to borrowers with the highest credit scores (A+ paper). This is due to the interest rates charged by credit unions making risk-based loans.

“Given the pervasiveness of other lenders charging excessively high rates, credit unions are able to price non-prime loans for risk and effort—and provide members a better deal,” the Steer Clear report finds. “Credit unions’ non-prime used auto loan rates, while necessarily higher than credit unions’ prime rates, are significantly lower than what borrowers could receive from other lenders.”

Lesson 2: Reduce the underwriting gap by transferring traditional character lending techniques into an automated decision-making process.

Applying traditional character lending, credit unions try to thoroughly understand why applicants’ credit scores are low, pay attention to positive or negative movements in their scores, and evaluate what plans members make to improve their financial situations.

“This hand-holding also acts as a risk mitigation measure,” the Steer Clear report suggests. “This approach can be extended from going over the credit report with borrowers, to building budgets, to car-buying workshops, to assisting the members in reviewing paperwork from dealers. The trick for credit unions in non-prime auto lending will be to automate the use of the traditional underwriting process—character traits included—to supplement credit scores, or to evaluate and subscribe to bureaus that gather a wider spectrum of consumer data.”

The Steer Clear report identifies several credit bureaus and scoring agencies working to assess credit risk among applicants with “thin files.”
Underbanked Markets chart from Fair Isaac

Lesson 3: Get in front of dealers by assisting members in finding cars.

Whether by making agreements with a “select few dealers,” providing online car-buying services, or sponsoring used car sales, the Steer Clear report suggests ways to “maintain direct contact with borrowers—and to ensure that members get good deals on reliable used cars.”

By assisting members in finding cars, “credit unions can effectively steer members away from modern loan sharks.”
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Lesson 4: Employ a “hard close” to cement bonds with members.

Credit unions should employ the opportunity to educate borrowers and reinforce the value of membership when closing every loan.

The Steer Clear report finds that “This process of documentation, education, and loyalty building provides a solid defense against the increased delinquency that comes with moving down the credit score scale.”

Lesson 5: Insure borrowers against events out of the realm of their control.

Successful non-prime auto loan programs “include protections for the borrower as well as the credit union.”

The Steer Clear report outlines the mechanics of everything from credit disability and credit life, to guaranteed asset protection, mechanical breakdown insurance, and debt cancellation.
Primary Causes of Default Among Loan Financing Programs with a Loan Component

Lesson 6: Export risks by using available loan loss insurance products and guarantees.

Different sets of coverages can directly protect credit unions making non-prime auto loans. The Steer Clear report profiles default and collateral protection insurances designed to reduce credit unions’ risks.

The report also identifies non-profit organizations that are willing to provide partial guarantees against credit unions’ non-prime lending losses.

Other innovative approaches include selling portions of non-prime auto loans via participation agreements with other institutions, or selling whole loans on the secondary market. In each arrangement, the originating credit union can retain the servicing.

Lesson 7: Keep in touch with borrowers by allocating resources to monitor and collect loans at the first sign of trouble.

Many credit unions interviewed in the Steer Clear report agree that to sustain non-prime loan programs, it’s critical to modify collections processes and engage in “proactive collection.”

For example, these leading credit unions maintain that borrowers with lower credit scores should receive attention more quickly – within 1 to 15 days of delinquency – rather than waiting 30-60 days. This attention is intended to be aggressive, but not abusive.

The report goes on to describe eight success factors in non-prime loan collections. These factors illustrate the importance of creating and maintaining open communications with non-prime borrowers.

As the report concludes, “Our surveys and interviews revealed many examples of used auto lending programs that have proven successful—both in terms of providing affordable car ownership for non-prime borrowers and sustainable business strategies for credit unions.”

Steer Clear Across America

All credit unions and suppliers profiled in the Steer Clear report encourage more credit unions to engage in non-prime used auto lending. They invite other credit unions to consider replicating or adapting their programs to serve non-prime borrowers across America.

NCUF will be taking model auto loan programs on the road. “We plan to bring the Steer Clear project to a national scale by adding non-prime auto lending options for credit unions to offer through REAL Solutions,” says NCUF Executive Director Steve Delfin. “By saving used car buyers thousands of dollars on reliable transportation to work, we hope to create more discretionary income for these low-wealth borrowers. The Steer Clear project has the potential to achieve transformational philanthropy that will strengthen the financial security of households across America.”

About the Steer Clear Project

The Steer Clear research project was funded by a grant from The Annie E. Casey Foundation to the National Credit Union Foundation. The Aspen Institute helped facilitate the work under this grant.

NCUF thanks the Casey Foundation for their support, while acknowledging that the findings and conclusions presented in the Steer Clear report do not necessarily reflect the opinions of the Casey Foundation.