Contributing Author: Steve Klees, Senior Vice President, Specialty Channels, EFG Companies
For the past several months we’ve heard arguments across the industry about whether a subprime bubble is forming. Experian has stated in at least the last three quarterly State of Auto Finance updates that there simply is no bubble. I tend to agree. Here’s why:
For an economic bubble to form in the auto industry, the prices of vehicles must inflate well beyond the actual vehicle value, past what the market can bear. While prices for both new and used vehicles have gone up in recent years, the market is still very capable of handling those prices. The main reason for this is the combination of low interest rates and longer-term loans.
For example, take a subprime consumer who purchased a vehicle in 2009. Because of the stringent lending requirements at that time, that consumer locked in a 9% interest rate on a 60-month term loan. Then, in 2014, they decided to trade in their vehicle for a newer used-model vehicle. Because the consumer kept up with their monthly payments and possibly made other credit strides with better employment, etc., they returned to the dealership as a near-prime consumer, and were able to refinance the remaining balance into their new vehicle payment at a 3.9% interest rate. With a new 60-month term loan, their payments stay roughly the same. The consumer already proved they could afford those payments with the first vehicle, so the risk remains roughly the same.
According to Experian, the average length of vehicle ownership has increased to 7.7 years with an average loan term of 5.6 years. Meanwhile, today’s average consumer is between 35 and 59 years of age with a near-prime credit score, and a high likelihood of purchasing a newer-model used vehicle. In addition, APR is slowly beginning to creep up to continue meeting the market demands that go along with longer terms.
Granted, there are a lot of variables keeping the bubble from forming. Beyond the APR creep, unemployment continues to go down and consumers are prioritizing their vehicle payments over other forms of credit, like credit cards. If one of these changes, alarms will go off to alert the industry. Meanwhile, it’s important to control what you can to fortify your institution with an eye to the future.
In general, with longer-term loans comes more opportunity for default. It is possible to increase control and recoup more potential losses beyond setting a higher APR with strategic F&I products, like vehicle return or a vehicle service contract. Products like these can potentially enable subprime consumers to stay current on their auto loan payment when unforeseen circumstances occur, such as a vehicle breakdown or involuntary unemployment.
By providing a sense of security from life’s unpredictable nature, you could have better control over your loan portfolio while also differentiating your services for dealers and consumers. Complimentary consumer protection products address pressing consumer needs which, in turn, help dealerships demonstrate their commitment to their customers. Dealers offering complimentary F&I products also have the opportunity to further increase their bottom line with through the sale of upgrades, as well as the potential to boost CSI scores and increase retention and referrals.
With almost 40 years of experience in helping dealerships and lenders navigate the sometimes choppy economic waters to maintain and grow profitability, EFG knows how to guide your institution to new levels of prosperity. Contact us to find out how today.