The defi Team defi INSIGHT

The economic situation in the United States has been rather frenetic over the past four years due to a number of unforeseen factors. The quick recovery from pandemic-related economic pressures saw the US economy regrow faster than any other developed country through 2021. Despite the fact many economic indicators continue to remain positive, not everything has turned out sunshine and roses for the auto lending sector. Specifically, high inflation rates resulting from continuing supply chain issues and increasing interest rates due to the Federal Reserve’s fight against inflation have hit providers of auto loans. Recessionary fears may be overblown for the rest of the economy, but for lenders, there’s not much good news, especially when it comes to auto loans. Recessions normally are easy to track, but this current economic malaise seems not to be following the rules of past recessions.

While the decline in industrial output and retail sales in the last quarter of 2022 showed that the economy is indeed slowing, January saw signs that the economy was still growing too quickly for the US Federal Reserve’s liking. As the Fed has been tasked with tamping down inflation, they decided to raise the Fed funds rate by another quarter basis points to 5 percent, the highest level since before the Great Recession. Auto loans will no doubt be affected by rising interest rates, and combined with the high inflation of the past couple of years, it’s likely this will slow automotive sales further. In fact, in 2022, sales of light vehicles fell to their lowest levels since 2009, leading many lenders to see the current economy as an auto loan recession.

Is This Just an Auto Loan Recession?

Though job growth hasn’t slowed markedly, and certain other economic factors show a soft landing for much of the US economy is likely, other factors don’t look so positive for auto lenders. The consumer lending sector has suffered over the past year, with the Fed rapidly raising interest rates to slow inflation. This also had some unforeseen effects that don’t bode well for lenders for the foreseeable future.

As the current House leadership refuses to raise the country’s debt ceiling without concessions, which would lead to the first debt default in US history, three major banks have also failed. Though these bank failures are mainly due to poor management, this was acerbated by higher interest rates. Meanwhile, geopolitical issues regarding decreased oil production by OPEC and a continuing conflict involving one of the world’s largest energy producers are driving fuel prices up, which will likely affect the sales of certain gas-powered vehicles. Add to this the fact that Americans borrow an average of $41,665 for new vehicles and $28,506 for used vehicles, and this is indeed a recipe for an auto loan recession. To survive, many auto lenders are turning to technology.

Technology can mitigate the effects of economic downturns by:

  • Calculating which applicants are most likely to make payments on time.
  • Combining and analyzing economic indicators like employment history, debt-to-income ratios, and credit history to determine how much and to whom to lend.
  • Determining which borrowers will most likely repay auto loans by evaluating credit histories.
  • Ensuring borrowers are economically stable by looking at work and payment history.
  • Establishing what loan amount an individual customer can repay.
  • Estimating what loan amounts specific customers can afford.
  • Identifying changes in risk profiles by tracking borrower behavior.
  • Recognizing the best loan candidates by looking at demographic information.
  • Using historical data to decide who to approve for loans.

Economic pressures on individual car buyers often factor into whether to take out an auto loan. Recession-related fears, potential layoffs, inflated prices, and even continuing supply chain issues may cause some consumers to wait until conditions are more stable.

Is There a Broader Recession Coming?

While it’s been established that the US economy will likely land softly, the future is more uncertain for lenders. Recessions sometimes hit certain sectors harder than others, and the economic pressures on auto lenders and their customers will likely be felt into the future. As such, this recession will likely continue to affect auto loans through 2023 and maybe beyond.

Leading economic indicators in February 2023 declined 0.3 percent for the eleventh month in a row. Though these declines have been tempered in recent months, the Fed’s decision to raise interest rates again in March is unhelpful for anyone wishing to take out an auto loan. Recessionary pressures and high-interest rates led to the failure of three US banks, for which the Federal Deposit Insurance Corporation (FDIC) took extraordinary measures to prevent wider problems in the banking sector.

This adds to concern that the US economy may indeed dip into a wider economic downturn. In the end, however, for someone seeking an auto loan, recessionary forces may not matter all that much. When someone’s determined to buy a vehicle and has the means to repay debt, they’ll go forward with a purchase regardless. For the lender providing an auto loan, recessions don’t really matter if an individual car buyer ticks all the right boxes and looks like a reasonable risk. In the end, all that matters is whether they can afford to repay the loan.  

Leveraging Affordability Data

That’s why affordability data is so important during uncertain economic times. When a consumer takes out an auto loan, recessions can affect borrowers’ ability to make payments, even those with excellent credit scores and histories. To ensure this won’t happen, lenders need to do their due diligence by collating and analyzing the data at their disposal to ensure a borrower can repay an auto loan. Recessions are times when auto lenders need to take a good, hard look at each applicant and evaluate whether they pose a risk that’s worth taking. To target the right customers and present them with the best offer, lenders need to leverage affordability data.

This involves:

  • Building audiences based on whether they can afford certain vehicles and loan amounts.
  • Guiding customers towards the vehicle and loan amount that best suits their economic situation.
  • Making offers that are relevant while also providing shrewd alternatives.
  • Personalizing products based on real-time data.
  • Providing an experience for customers that permits easy and quick access to decisions.
  • Utilizing existing customer data.

For lenders who can take advantage of affordability data when considering an applicant for an auto loan, recessions won’t raise risks noticeably or be as scary to their bottom lines. Looking at this type of data differs from looking at credit histories or other historical data, as it looks forward rather than backward. By considering different scenarios that may impact a borrower’s financial situation, auto lenders can better shield themselves from risk.

Affordability data looks at potential economic impacts like:

  • Higher interest rates
  • Income or job changes
  • Rising consumer costs

Adding current data to the review of historical data means the risk of rejecting applicants capable of making payments on time will go down while also lowering the risk of approving applicants who will struggle to make payments. Credit histories and credit scores often don’t tell the whole story, and alternative credit scores that look at such things as utility payments, rental records, and similar data can improve a lender’s portfolio performance while not increasing risk.

How defi SOLUTIONS Can Help Lenders With Auto Loans in a Recession

With defi SOLUTIONS, it’s never been easier to assess an applicant for an auto loan. Recessions will always affect borrowers and lenders, yet risk analysis is imperative for finance companies during any economic downturn. That’s why embracing technology that aids lenders with evaluating affordability and other data is more important than ever, as lenders walk the tightrope between approving auto loans and trying to prevent defaults.

Technological risk analysis solutions offered by defi help lenders:

  • By providing an integrated solution with access to data and insights through defi ORIGINATIONS software so that they’re able to access information through a single login portal.
  • Configure dashboards that enable lenders to enhance their perspective on their loan portfolios to better understand the data that matters to them.
  • Establish relevant insights for underwriting, funding, and other professionals within the organization. 
  • Quickly and easily aggregate and analyze data to develop relevant reports while allowing a deeper evaluation of the data when necessary.

Technology has become essential for lenders trying to determine which loan applicants present the least risk. In order to survive an economic downturn, lenders need reliable data sources coupled with data analytics software that can accurately assess the risk present in a lender’s portfolio. In fact, there’s no better time than during a recession to embrace defi’s cutting-edge analytics and other technological solutions.

Getting Started

defi SOLUTIONS is redefining loan origination with software solutions and services that enable lenders to automate, streamline, and deliver on their complete end-to-end lending lifecycle. Borrowers want a quick turnaround on their loan applications, and lenders want quick decisions that satisfy borrowers and hold up under scrutiny. With defi ORIGINATIONS, lenders can increase revenue and productivity through automation, configuration, and integrations and incorporate data and services that meet unique needs. For more information on thriving through this auto loan recession and how defi can help, Contact our team today and learn how our cloud-based loan origination products can transform your business through an economic downturn.

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