Brien Joyce
Vice President
EFG Companies
The topic of interest rates is a popular one among lenders, sparked by the quarterly Federal Reserve meetings, and debated by those with contradictory opinions. As a case in point, let’s review the recent comments made by Moody’s Analytics during the Auto Finance News Performance and Compliance Summit. According to Michael Vagan, assistant director and lead auto economist at Moody’s Analytics, “The Federal Reserve waits too long to raise interest rates. They [the Federal Reserve] wait to make sure the economy is strong and inflation is growing – then they increase interest rates. But, what inevitably happens is they wait too long so then they have to act quicker and more aggressively to cool the economy down.”
In March, the Fed raised interest rates a quarter of a point to between 1.5% and 1.75%, and have signaled rates will be hiked two more times before the end of 2018. However, Moody’s believes interest rates will pick up steam much faster, predicting interest rates will be above 3.1% by 2019. The truth is likely somewhere in the middle. Regardless of what eventually comes to pass, forecasting interest rate hikes impacts auto lenders and consumers in the near term.
It’s time to plan
Unless your crystal ball has some magical powers, there is little you can do to actually affect rates. However, you can and should plan for interest rate changes. Develop a series of scenarios and build strategies to respond to each one. While it might seem counterproductive, the time spent on this exercise can mean the difference between a nimble response and being caught flat footed.
Communicate with consumers
Consumers often respond negatively to interest rate hikes. They perceive that their money will not go as far, and they curtail or delay major purchases. It’s important for auto lenders to clearly communicate with consumers about the true effects of various interest rates over the life of a loan.
This is also a good time to discuss the value of good credit with consumers. Credit can mean the difference between good loan terms and not even getting approved. Make sure your customer understands how credit is established and what actions positively or negatively affect a rating.
Be creative
Adding consumer protection products to a deal automatically boosts the value of a deal. Products like a vehicle service contract or vehicle return protection meet the needs of your customers and help insulate your auto loan portfolio from risk.
Think of it this way – what makes more sense?
- An auto loan with no protection products or other valuable benefits to incentivize consumers to choose it beyond APR and terms; or
- An auto loan with a protection product that enables customers to potentially stay current on their auto loan in the case of a mechanical breakdown and fix their vehicle with minimal impact to their monthly budget. This product helps the loan stand out and provides customers a compelling reason beyond APR to select it for their financial needs.
The second option is a no-brainer!
Evaluate your portfolio
Now is a good time to pull some data on your current customers – as well as those customers you want to attract. Have net income metrics increased or decreased? Where are your customers in their stage of life? Changes in interest rates can affect people differently. Lower income customers who are more susceptible to interest rate hikes will feel a monthly payment increase. Higher earners, or those with better FICO scores, may pay less attention.
If your portfolio leans toward super prime borrowers, interest rate hikes might be a good time to consider boosting your near prime volume. As the incentive of low interest rates fades, credit options decline for these borrowers. With consumer protection products built around a near prime loan, the value of that paper has the potential to increase. Interest rate increases demand agility from lenders.
Walk through these scenarios with your team and build some strategies. Then, you’ll be better prepared regardless of what the future brings.