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SUBPRIME AUTO BUBBLE: WHEN, HOW, AND WHAT TO DO ABOUT IT

The defi Team defi INSIGHT, defi LOS

subprime auto bubble

 

Outstanding auto loan debt reached $1.27 trillion in the final quarter of 2018. Earlier this year the New York Fed Consumer Credit Panel and Equifax reported that more than 7 million auto loans were at least 90 days past due. That’s the highest number reported since 2012.

 

Consumer Auto Loans, Past Due, US, 1999-2018

That statistic counters the news of a healthy economy, low unemployment, and wage increases. But there are underlying factors that might explain the growing delinquency rate.  

 

  • Average car prices have been increasing, with some of these costs associated with sophisticated technology such as GPS, collision avoidance, and predictive maintenance now included in new vehicles.  
  • Gradually increasing loan rates – the average prime is around 4.7%, the average subprime exceeds 12%.
  • Demand for longer-term loans, approaching 6 years on average, help reduce monthly payments but increase overall loan costs.
  • Vehicle required to commute to work. Previously unemployed are upgrading to more reliable used vehicles that take a bite out of every paycheck. Commute distance and rising gas prices further erode discretionary income.

 

According to the New York Fed and Equifax report the subprime and near-prime segments show the greatest increase in delinquencies over the past 6 years.

 

Consumer Auto Loan Delinquencies, US, 2002-2018

subprime auto bubble

Source: New York Fed Consumer Credit Panel and Equifax

 

How should subprime lenders interpret and respond to these data?  The overall trend has been gradual, so it shouldn’t come as any surprise lender, though the recent uptick in the subprime segment does merit attention. If that’s the beginning of an accelerating trend, subprime lenders need to carefully evaluate their credit policies, monitor delinquency trends, and analyze any defaults. The results of this analysis should then be used to modify credit policies and lending decisions to minimize the future impact of defaults on their portfolio and avoid becoming a victim of any subprime auto bubble.

Subprime Auto Bubble: Tactics and Strategies

Use Analytics to Understand Sources and Probability of Defaults

Any subprime lender concerned about increasing delinquency levels should analyze their portfolio to identify borrower characteristics and attributes which correlate highly with defaults. Careful analysis may reveal certain dealers with high-volume used vehicle sales where a deal is more important than properly qualifying borrowers. Analyses may also show correlations among LTV, down payments, rates, length of loan, or other factors that indicate a likelihood for defaults. Based on the findings, lenders should tighten their credit policies to avoid the risk of future defaults.

Proactively Address Potential Delinquencies

Findings from default analysis can also enable lenders to proactively identify subprime loans trending toward delinquency. Analysis of current portfolios can reveal loans with characteristics closely matching loans that have defaulted. With this information in hand, lenders should contact borrowers likely to become delinquent and offer alternative loan structures to circumvent the occurrence.

Trended and Alternative Data Improve Lending Decisions

Lenders can minimize their exposure to a subprime bubble by taking advantage of the latest credit and consumer data resources. These data augment traditional credit scores to provide confident, well-reasoned lending decisions.

Trended Credit Data: History, Not Just a Snapshot

Trended credit data can add more context to a simple credit score by letting lenders review as much as 30 months of tradeline history to evaluate payment trends. Compared with the snapshot of financial strength provided by a credit score, details on the consistency of monthly payments can indicate increasing or decreasing financial resources.

 

Although two consumers may have the same credit score, a consumer who consistently pays more than the required minimum credit card payment represents less risk than a consumer who pays the minimum and has taken out a payday loan and repaid it promptly. The insight provided by trended credit data can increase your confidence in making lending decisions that reduce exposure to subprime defaults.

Alternative Credit Data Provides a More Detailed Picture  

Lenders focused on subprime should also take advantage of alternative credit data to obtain a more detailed understanding of an applicant’s financial strength. Alternative credit data includes consumer data like utility and cellphone payments, change of address, rental payments, and public records. The additional information helps lenders reduce subprime loan risk with a clearer picture of an applicant’s ability to repay. An applicant with a subprime score who has moved a lot in the past three years is a higher risk than someone who’s been in the same apartment complex for four years and has not missed a cellphone payment.  

Subprime Auto Bubble or Not, Lenders Have the Resources to Protect Portfolio and Profit

Are we on the verge of a subprime auto bubble? As someone involved for many years in auto lending, we hope not. Regardless of the market’s direction, we think proactive subprime lenders will 1) Use analytics to spot potential subprime defaults; and 2) Offer borrowers trending toward delinquencies alternative deal structures.

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Getting Started

defi SOLUTIONS loan origination and analytics software experts understand the challenges of the subprime markets. We offer the latest in fintech capabilities to help lenders proactively identify and reduce risk. Take the first steps toward data-driven lending decisions by contacting our team today or registering for a demo of defi LOS.

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