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Still scared of subprime? Don’t be.
It turns out that lending to borrowers with lower credit scores doesn’t have to be dangerous for your credit union. In fact, it can be a key facet of your loan-growth strategy.
After the mortgage crisis, “subprime” might as well be a four-letter word. But the truth is you can add subprime borrowers to your auto loan portfolio without setting your credit union up for failure.
Other credit unions are trying it. Experian’s first-quarter figures show a year-over-year increase in credit union subprime auto lending of 6.76%, and subprime loans now account for 34% of credit union auto portfolios.
But before venturing too quickly into subprime lending, credit unions must reassess risk safeguards to optimize this prospective revenue and loan growth opportunity.
The cornerstone of managing auto lending risk—both prime and subprime—is protecting collateral. While most lenders require borrowers to carry insurance, the reality is that some borrowers don’t make necessary repairs.
Then there are the examiners. In light of the economic environment, both state and federal examiners are scrutinizing loan portfolios to ensure they are adequately protected.
This is why lenders carry insurance.
As always, credit unions have options. One choice is a blanket policy that covers all financed vehicles. Managing this coverage is simple: credit unions pay their premiums and then file claims when a vehicle has sustained damage.
As they are with all insurance products, premiums are determined based on a variety of factors but they generally drop as deductibles rise.
A second option is tracked collateral protection, which force-places insurance on vehicles and passes along the cost to the otherwise uninsured borrowers. The coverage protects the credit union, not the member. Members have to be notified and premiums are incorporated into payments.
Most credit unions recognize these as their basic options. What they sometimes don’t recognize are the other opportunities they have to manage the cost of collateral protection insurance.
Some credit unions, for example, keep their blanket premiums low by carrying a high deductible. They assume some of the risk—and cost—of minor repairs and pay for those out of reserves. They save on staff because there isn’t any member insurance information to track and no insurance company communication to manage.
Credit unions using tracked collateral protection insurance have options, too. Jefferson Financial Credit Union, for example, uses an outsourced tracked collateral protection program for its 8,500 new and used auto loans.
The Metairie, La.-based credit union had switched from blanket coverage primarily to save on premiums. When it made the change, it also adopted a new policy and a new product that helped mitigate the risk of lending to its lowest-grade group of borrowers.
The $726 million asset credit union now installs tracking devices in all vehicles financed for borrowers with credit scores below 600. The GPS-enabled device signals with blinking lights when payments are due, and this reminder has reduced delinquencies and charge-offs. The device also makes it easier to find and repossess vehicles if necessary.
Of course, the tracking devices are just one tool credit unions can use to manage the risk of subprime lending. There are other tools and insurance options that can protect credit unions and enable them to explore new revenue streams with confidence and security.
The key is accurately assessing the risk associated with any new revenue stream and then adequately safeguarding against it.