MADISON, Wis. (7/28/14)--A July 21 article in
The New York Times
described how the subprime auto loan market has grown 130% in the five years since financial crisis, with roughly one in four new auto loans last year going to borrowers with credit scores at or below 640. Credit unions and banks approach the market quite differently.
The increase is driven by some of the same factors that fed the runaway growth of subprime mortgages that led to the financial crisis, the article explained. Banks are charging rates that can exceed 23% and making loans to consumers without the means to make payments. And, as with subprime mortgages leading into the Wall Street implosion, some subprime auto loans are bundled into complex securities sold as investments--a process that creates more demand for the loans. (See related story: Auto loan balances race to all-time high: Equifax.)
The vast majority of banks largely rely on dealers to screen potential borrowers. The arrangement, which means the banks rarely meet customers face to face, mirrors how banks relied on brokers to make mortgages.
Credit unions interviewed by
take a vastly different approach to subprime auto lending. "We're trying to set our members up for success," Jim Brown, senior manager of consumer lending at University FCU, Austin, Texas, with $1.7 billion in assets. "The last thing we want to do is set somebody up to fail."
University FCU participates in Non-Prime Auto Loans, a partnership between the National Credit Union Foundation and the Filene Research Institute that tests the viability of subprime auto lending in credit unions. Fourteen credit unions participate in the program.
"These are members who have the fewest options out there," Brown told
. "Credit unions were initially formed to serve these members: the underserved. We've found that if we help these members, they're very loyal, and they come back to us time and time again for future loans."
University FCU has been offering subprime auto loans since 2004. The credit union classifies subprime auto loans as D and E loans, which represent consumers with credit scores below 600, Brown said. The credit union currently makes the loans at annual percentage rates between 12.05% and 14.85%
"In our market, we have people who are coming to us that were at 23% and 24% through dealers and other financial institutions," Brown said.
Among the keys to making subprime auto loans is focusing on the overall member relationship. Seasons FCU, Middletown, Conn. with $142 million in assets, also participates in the NCUF/Filene subprime auto loan initiative. When it screens subprime applicants, the credit union considers if the member has a direct deposit or a checking account with a debit card, said Jeff Rindfleisch, vice president of financial services (
Indeed, credit unions appear to know their members before lending to them for subprime loans. While subprime auto loans account for 14.2% of credit union auto lending portfolios, compared with 13.7% for banks, credit unions' 30-day delinquency rates on subprime auto loans in the first quarter of 2014 was 1.20%, compared with 1.93% for banks, according to data from Experian.
Denver Community CU, with $263 million in assets, is another NCUF/Filene program participant. "One of our components of underwriting that we take a lot of pride in is lending based on character, and that can make or break a program like this," Tessa Bonfante, Denver Community CU chief operating officer, told
. "You do need to understand the member and ask what their intent is and how they are trying to improve their lives financially to create some kind of comfort that lending to them is going to work."
In many cases the vehicles provided through subprime loans can literally change lives. "It can be a matter of going to work, or getting to the doctor's office," said Helen Gibson, Denver Community CU vice president of marketing and education.