How Lenders Can Solve America’s Underserved Auto Buyers Lending Crisis
Predatory interest rates, short-term loans, and co-signer requirements for “near prime” Thin-File or No-file First Time auto buyers are creating a financial crisis for millions of Millennials and Gen Z borrowers. A new marketplace solution is available to lenders and consumers that significantly mitigates lender risk, allowing lenders to competitively serve this market without significantly limiting loan amounts and payment terms, requiring co-signers, demanding exorbitantly large down payments or charging predatory interest rates to offset lending risks. As a result, lenders now have a unique opportunity to serve this valuable but underserved market safely and be part of the solution!
The purpose and scope of this paper is to identify common and often times discriminatory lending practices that frequently damage the borrowing ability and future creditworthiness of valuable Millennials and Gen Z borrowers who play an important role in the future of credit unions and banks alike. Here I provide a solution that will allow lenders to effectively and profitably serve the thin-file / first time auto buyer marketplace now, and for years to come.
INTRODUCTION
It should be no surprise that banks and credit unions are the primary new and used auto lenders. In fact, Credit Unions were crowned the “King of Auto Lending” for the first time in 2022, with one in four vehicles being financed by Credit Unions in the 4th Quarter 2022. According to Experian’s State of the Automotive Finance Market Report: Q4 2022, “The biggest driver of credit union growth was lower interest rates for both new and used vehicle financing. Even as interest rates overall have increased since the latter half of 2022 and into 2023, credit unions have managed to be a full percentage point lower than other lenders,” said Melinda Zabritski, Experian’s senior director of automotive financing. Overall, these statistics apply to seasoned borrowers at the high ends of the consumer markets and Credit Spectrum with overall credit scores 680+.
CAUTION: Before lenders spend too much time basking in the glow of competitive leadership, it is important to take a closer look at the underserved core of the auto lending market.
Certain segments of the consumer marketplace, specifically younger applicants and other segments of the “thin-file” - no Credit Score - marketplace are facing a growing economic crisis. Credit unions in particular have an unprecedented opportunity (if not a philosophical mandate) to capture and serve a large share of this underserved “thin-file” Millennial and Gen Z market. And the opportunity for Credit Unions and other FI’s in this market is not just for the First-Time auto loan; these consumers are the most underserved overall for all other related financial services needs. To clearly expose the scope of the problem, I’ll take a deeper dive into the current state of auto lending.
Spoiler Alert: Today’s thin-file, first time auto loan borrowers are faced with high auto prices, higher cost of auto insurance, limited lender funding, short loan terms, prohibitive interest rates, and higher cost of auto insurance, all of which result in high monthly payments that exacerbate increasing default rates … and I haven’t even touched on the negative issues with co-signers yet.
Millennials are the largest generation in the United States, comprising nearly 60% of the workforce and accounting for more than 20% of American consumers’ discretionary spending. Combined with Gen Z consumers, they make up well over 50% of the 60 million “thin file” consumers. With an average credit score of 647, Thin-File Millennials and Gen Z borrowers are treated like Subprime borrowers. Why? They simply have not had the opportunity to prove their creditworthiness.
Historically, APR’s and Terms (for the small percentage of Thin-File/First-Time borrowers actually approved) mirror the approval rates and structures for Sub-Prime auto borrowers. Thin file borrowers are unfairly disadvantaged due to lenders’ inability to assess their risk by traditional means. In 2022 for example, only 17% of new auto loans were approved for applicants with no credit scores and for thin file borrowers and only 21% of used auto loans were approved for the same group.
Most lenders agree that a typical thin-File borrower does not represent the same risk as a seasoned Sub-prime borrower, but in the past and present, those same lenders have simply not figured out an effective and long-term solution to appropriately assess and consistently mitigate the risks that assure lender recovery for thin-file buyers’ losses. This paper definitively introduces that solution.
Tens of millions of Millennials, Gen Z and unseen and consumers (60 million+ consumers in all, according to a recent Experian report) represent the new “underserved.” As indicated by the distribution chart to the right, this “near-prime market represents better first-time buyer opportunity for both consumers and lenders versus the subprime market.
As defined by Experian, TransUnion and Equifax, a thin credit file typically refers to a credit history with fewer than five credit accounts on a credit report. Millennials and Gen Z borrowers make up a significant percentage of tens of millions of “thin file” consumers … who simply have not had the opportunity to prove their creditworthiness and are treated like Subprime borrowers.
Credit Bureau scoring models need at least one or two active credit accounts with three to six months of activity on a credit report to even generate a credit score. If an applicant has a thin file, a lender may not be able to obtain a credit score. In many cases lenders dismiss high thin-file applicant credit scores when considering a loan application because of the lack of payment history, typically resulting in a loan decline.
Those lenders sincere in helping this market typically request a matrix of requirements such as Co-Signers, high down payment, limited monthly payment terms, as well as significantly higher interest rates to compensate for not being able to fully assess loan default risk using a score. And still, in the majority of cases, traditional lenders decline more than 50% of these potential borrowers, even with Co-signers. Additionally, many applicants will decline to accept financing approvals with such non-competitive restrictions and requirements that lenders impose, thus inadvertently pushing many of these good potential borrowers to sub-prime lenders and dealers.
Let’s take a deeper look into the root of problem, the resulting consequences, and the solution.
A Growing Influx of Younger borrowers. The market for new and used auto lending will continue to grow as younger and other unseasoned borrowers enter the workplace and continue to finance their first cars. In Jerry’s 2023 State of the American Driver Report 43% of Gen Z members said they had bought or leased their current vehicle since 2020. This was the highest rate during that time span of any generation.
High interest rates. A significant amount of First-Time auto loans are being made by high interest lenders, with one in five Gen Z’s saying their car payments account for over 20% of their after-tax income. There is and will continue to be a market for Thin-File and First-time borrowers. However, the majority of these consumers have been and will continue to be captured by Buy-Here-Pay-Here as well as Non-prime and Sub-prime lenders, unless traditional lenders decide to enter this market with new solutions.
Inflationary prices. According to the World Economic Forum, Americans under the age of 40 have grown their vehicle-related debt the most, with the highest % of their income going toward auto-related payments and maintenance. Today’s inflationary environment has pushed used car prices to new highs. The Fed reports that the average auto loan is now $24,000, up 41% from 2019’s value of $17,000. [ Note to Lenders: If your current First-time / Thin-File auto loan program is limiting loan amounts to under $24,000, you are likely pushing your borrowers into older, higher mileage, and more likely to break down (thus more apt to default) vehicles.]
Increasing the financial burden of Thin-File/First-Time buyers: The convergence of inflationary automobile prices, a high consumer demand for new and used automobiles, the requirement for Thin-File/First-Time auto buyers to find co-signers, make high down payments, and accept high interest rates and shorter payment terms, results in historically high loan payments. High payments result in high default ratios, which then have serious and long-lasting negative effects on these borrowers’ creditworthiness as well as the lender’s ROA.
Consider the following:
• Since the outbreak of COVID-19, the total dollar value of auto loans taken out by people under 40 has risen at the fastest pace on record in data going back to 2000. The total balance for borrowers 18-29 rose about $50 billion, or 31%. For those 30-39, the rise totaled about $80 billion, or 29%. Commensurately, defaults and loan losses in these borrower segments have increased.
• Four out of 10 Gen Z drivers say they pay more than 15% of their after-tax household income on car payments , while one in five say they pay more than 20%. More than a third of Millennials say they pay more than 15%, and 16% pay more than 20%. And these are just within the segment of borrowers that were approved. Loan declines also rose during this period, meaning lenders did all the work of underwriting and decisioning, only to increase the percentage of declines, thus significantly reducing operational efficiency.
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More than half of Gen Z drivers (52%) say the high cost of car ownership caused them to make at least one non-car monthly debt payment (credit card, mortgage, rent, etc.) at least 30 days late in 2022. A third (33%) of millennials said the same. High interest rates and short-term loans for Thin-File / no-file First-Time auto buyers are creating a financial crisis for millions of Millennials and Gen Z borrowers and their co-signers. In addition, these high-rate First-Time car buyer programs increase lender risk and associated expenses. According to Bankrate, the number of drivers becoming delinquent on their auto loans following the pandemic has been on a steady rise over the past few years due to the combination of higher vehicle prices and steep interest rates. One population that has been especially affected is drivers between the ages 18 and 39 – millennials and those in Generation Z.
Another underserved segment of consumers is the “unseen” buyers (many legal ITIN Residents) who purchase vehicle after vehicle for cash because they don’t have sufficient credit and choose not to apply for fear of being declined. They are working and have good cash flow and would like to make a step up to a financed purchase. However, they are invisible to traditional lenders and established loan review and risk management policies and procedures.
The Unintended Consequences of Requiring Co-signers. In a nutshell, requiring a co-signer is a risky solution for the lender, the borrower and the co-signer alike. Co-signers incur credit, financial and relationship risk as they experience a reduction in their credit score and impaired ability to borrow money, suffer the financial consequences of primary borrower default, and experience a damaged relationship with the primary borrower and with the lender upon default. Requiring a co-signer generally results in increased underwriting time and higher rejections, not to mention a damaged relationship between the credit union and all parties to the loan, sometimes starting at the initial application and underwriting, and almost always in a default situation. Additionally, there is no guarantee that the co-signer will make the lender whole in case of default. The requirement for co-signers, while in some cases relevant, is generally an antiquated and typically ineffective way to offset risk. It’s just bad business.
Meet Jeremy Steben, millennial credit union member and former Thin-File/First-Time auto buyer: “For the first seven years after moving out on my own I lived in cities where everything was either within walking distance or accessible by public transportation. A car was an unnecessary luxury. By the time I moved back to the suburbs for a new job, I had gotten to the point where I wasn’t living paycheck to paycheck and was looking forward to affording my own apartment without roommates. I got a ride in a carpool for a couple of months while I saved some money to ensure this was a permanent move.
When the time came to purchase a car, I went to a local credit union to get a loan. I was completely confident walking into the office, there was no doubt in my mind I would be leaving with a signed contract. I was buying a used car directly from an acquaintance. It was 9 years old and in good condition. I had estimated that my monthly payments would be under $200 a month, even if my interest rate was on the high end. I had a decent credit score (renter, no prior auto loan) money in the bank, pay stubs indicating 6 months of local employment, with a salary that was obviously sufficient to make any payments.
I was completely floored when they informed me I needed a cosigner. I was also confused as my credit score should have been more than adequate. They told me my credit report was sparse. I had a student loan I was making payments on, and I had one credit card from my bank that I never used and sat in a drawer. There was also a lack of any prior auto-loan, as this was my first car, which made me a ‘first time buyer’. Between the lack of any history of revolving accounts and no auto-loans I was classified as a ‘thin credit’ customer and would require a cosigner.
This hit me like a punch to the gut. This most recent apartment was the first where I hadn’t had to ask my mother to cosign the lease. The thought of having to ask either one of my parents at this point in my life was humiliating. It wasn’t even an option though, they were making their own financial moves at the time and asking them to drop their credit score with an additional account was out of the question. I walked out of that Credit Union dejected and embarrassed. I had no idea what to do, the thought of asking somebody other than my parents to cosign a loan was inconceivable to me.”
Jeremy is now Director of Product Development & Quality Assurance with Suretys, the groundbreaking provider of PlusOne® insurance policies that revolutionize vehicle buying, leasing and loan approval for consumers with good cash flows but that don’t yet have the credit history to get financing without cosigners.
Jeremy’s message: “Lenders, don’t be discouraged . . . the answer to safely and competitively serving this market is here, in the form of insured “Co-Signer replacement” loan loss protection, allowing lenders to approve and service a high level of applicants protected against loan default losses, at reasonable but high yield APR’s, with the most competitive deal structure terms and at no cost to Lenders.”
With a borrower-financed insured replacement for co-signers, credit unions can now offer First-Time auto buyers competitive interest rates and terms eliminating the need for co-signers and other restrictive loan terms so that the lender default risk for Thin-File/First-Time auto buyers is no greater than for prime and super prime borrowers.
THE OPPORTUNITIES FOR LENDERS
The combined Suretys and Lengistics solution solves the traditional lenders’ front-end decisioning issues, as well as the back-end loan loss issues, allowing credit unions to capture and profitably retain a large share of this underserved market of Thin-File/First-Time auto buyers while helping to put these consumers on a positive financial path safely, efficiently and profitably.
Walt Agius, a 30-year Credit Union Executive and founder and Managing Member/Board Chair of Lendgistics, LLC (dba CU Lending Edge) and also the founder and CEO of a FinTech Loan Origination software platform sees it this way: “The day-to-day problem for lenders is managing risk in everything we do. But in the case of First-Time car buyers, the current risk management ‘solutions’ of requiring co-signers and high down payments, imposing high interest rates, and limiting loan amounts that force buyers into older higher-mileage vehicles, are not effective, marketable and sustainable processes for Lenders or consumers. The flaws in the most common risk management techniques for serving this marketplace don’t actually protect the risk that most lenders are trying to manage or cover at loan default.
The Suretys regulated, state by state-approved insurance product allows lenders to approve and fund more loans by covering their default risk (loss), one consumer at a time, based on the financial merits of each applicant. And rather than the lender paying the cost of coverage, each borrower pays for the cost of covering their risk. This could not be more fair or equitable to consumers or lenders; it’s the ultimate win-win in the marketplace.”
Agius continues, “This is the solution to the risk-management issues related to serving the Thin-File/First-Time buyer marketplace. Insured protection, backed by a $48 million, A-rated U.S.- based Insurance company and its subsidiaries, combining the resources of several experienced market providers that cover all the bases to help lenders implement a new solution to an age-old problem.”
The Suretys PlusOne Solution. Simply put, Suretys protects lenders from loan default loss who want to target Thin-File/First-Time auto buyers. Suretys groundbreaking PlusOne®policies are revolutionizing vehicle buying, leasing and loan approval for consumers with good cash flows but that don’t yet have the credit history to get financing without cosigners. Note that this solution is not for seasoned sub-prime or non-prime borrowers. Other programs exist for those particular segments of the consumer marketplace.
Suretys’ senior team consists of seasoned, successful insurance, finance, marketing, IT, and sales executives, as well as credit union executives, with years of experience and credibility in the marketplace. Says Josh Minsky, Founder and CEO of Suretys, “we saw a tremendous need in the marketplace. All of us including myself have had personal experiences being a first-time buyer and getting hammered on both the vehicle (which was older and very quickly after purchasing began to have mechanical issues), as well as being required to hunt down a qualified co-signer. And many buyers are required to ask for help from friends or relatives for help in other ways, like asking for big down payments, and even asking for us (at the prompting and behest of Dealers) to be involved in straw deals in order to help someone get an auto loan.
Backed by $48 billion, A-Rated, Markel insurance, Suretys’ PlusOne First time Buyer Program replaces the need for co-signers while protecting lenders from loan default from Thin-File and First-Time automobile borrowers. The Suretys policy becomes your co-signer on every loan. In other words, credit unions can safely capture Thin-File Millennial and Gen Z and other First-Time auto buyers, protecting them from predatory rates and limited loan terms offered by finance companies and subprime lenders, securing a high percentage of these members for life.”
How many times have Credit Union staff and management heard this from members? “My credit union was there for me at a time when no other lender would help me. I’ll be a member of my CU for life!” The Suretys program helps lenders capture a significant portion of a huge, underserved marketplace, and based on historic credit union service data and performance, many of those members will be retained for life.
Credit unions can competitively, sustainably and safely attract serve their Thin-File and No Credit History underserved members and potential members with this program.
Here’s how it works: The fully automated web-based Suretys Pre-approval process qualifies the applicant for the Suretys PlusOne policy, with a maximum monthly payment amount and term according to their financial history and Suretys’ proprietary algorithm. Knowing their maximum monthly loan payment and term allows a buyer to select a vehicle within the approved payment and term parameters. And then the dealer structures and closes the deal for the consumer, with Suretys allowing generous LTV’s including room for important consumer protection products like GAP and Extended warranty. Buyers can shop confidently for a high-quality vehicle knowing they are approved with a monthly payment maximum, and dealers know which vehicles qualify based on the maximum payment and generous payment terms. Lenders generate high yields with highly competitive market rates without worrying about significant losses due to the Suretys-protected loans. Loan losses for First-Time/Thin-File auto buyers are protected for the first 36 months of the loan term (as normal amortization decreases loan loss risk – there’s no need to have insurance against loss as the loan balance and vehicle values balance out). Both credit unions and dealers can turn a high percentage of typically declined requests into approvals, writing more (protected) loans for First-Time buyers, while Lenders convert those buyers into productive and loyal members.
Suretys PlusOne is not a sub-prime program and policies are not for people with a history of charge-offs or recent bankruptcy. Suretys approved buyers work through Suretys program lenders and dealers, creating stronger lender-dealer bonds and better dealer behavior overall. Suretys’ umbrella coverage provides the lender with reimbursement for repo fees, storage fees, and most importantly, the difference between auction sale proceeds and the outstanding loan balance covering loan default losses.
Lendgistics’ Role: Credit unions can work with any dealer they have a financing relationship with, and vice-versa. For those credit unions that don’t have direct dealer relationships, Lendgistics’ role is to bring multiple dealer relationships to the table that will instantly jump-start and maintain the program and market penetration at the dealer point of sale. Lendgistics also provides over 10 years of operational experience providing a number of outsourced loan origination, processing and validation services to lenders, including a completely automated Lender LOS platform that is integrated with DealerTrack and RouteOne in order to maintain strong dealer relations. Lendgistics additionally provides extensive dealer development and management in the indirect and multi-channel loan origination and market development space and providing a complete front-end (dealer interface) and back-end (Loan Underwriting, Validation, and Funding) for Lender support by staff that have many years of Credit Union lending and operational experience.
Agius sums it up this way, “We are proud that Suretys chose Lendgistics to represent them in this space and we expect great things from our lender partners as well as Suretys. In my professional experience, taking risks on the right new programs or solutions has actually never been risky. Think about all the things that Lenders and FI’s do today that they may have thought were risky initially, only because they were new. Look back and ask yourself where would that FI been had they not done that “new” thing, or where would they be today had they started that one, two, three years earlier? The certain way to miss success is to miss an opportunity!”
ABOUT LENDGISTICS. Lendgistics is a premier multichannel (multi-asset class) loan sourcing and lending resource for credit unions. Since 2011, Lendgistics has connected FinTechs and other consumer loan aggregators that have loan flow and need capital with lenders and asset managers that have capital and need loans. Lendgistics uses its proprietary LOS technology platform to manage each channel end-to-end on a turnkey, outsourced basis - from loan sourcing relationships to underwriting, processing and validating each loan file prior to funding to meet each lenders unique standards and criteria, to integration with third party servicers. Lendgistics generates auto loans via its sourcing relationships with more than 10,000 auto dealers (as well as other asset class loans). The Lendgistics platform is integrated with DealerTrack, RouteOne, CRS, Lending Tree, Open Lending, Vantage DMS, and others for maximum efficiency and market reach. For additional information please visit https://lendgistics.com.
MORE ABOUT SURETYS. Suretys’ groundbreaking PlusOne policies are revolutionizing vehicle buying, leasing and loan approval for people with good cash flows but don’t yet have the credit history to get competitive financing without co-signers. Suretys’ senior team consists of seasoned, successful insurance, finance, marketing, IT, and sales executives with corporate, entrepreneurial and startup experience, as well as Credit Union executives with years of experience and credibility in the marketplace. And Suretys is backed by $48 billion, A-Rated Markel Insurance. For additional information please visit https://www.suretys.com.
ABOUT THE HALES CONNECTION. The Hales Connection is a Corporate Communications Firm serving the Financial Services Industry. Mike Hales is an industry veteran: a CUSO executive, former NACUSO Board Member (2005 – 2022), Credit Union Consultant (Counter Intelligence Associates / The Rochdale Group), and Bank Consultant (Moss Adams Advisory Services). Mike is a former commercial banking executive with Union Bank, Bank of America and Bank of the West and served as Chair of the California Bankers Association Sales and Marketing Committee. He is a graduate of the ABA Bank Marketing Association School of Bank Marketing Management and Strategic Planning at the University of Georgia. Mike is a graduate of Lincoln University Law School and is the author of The Handbook of Consumer Banking Law (Prentice Hall) and The Language of Banking (McFarland). Mike can be reached at halesconnect@gmail.com. For additional information please visit https://halesconnect.wixsite.com/the-hales-connection.