Lenders who were unwilling to do business with credit-challenged borrowers have now loosened their credit standards. This gives many borrowers with less-than-perfect credit a shot to purchase a car they need.
Many lenders used to avoid subprime borrowers especially at the onset of the financial crisis, but they are now turning to the subprime market to boost their revenue.
However, consumer advocates are questioning the methods lenders use to make this possible.
The Washington Post reports that some lenders have gone beyond the traditional sources of information—Equifax, TransUnion and Experian—for assessing borrowers’ creditworthiness. They turned to alternative sources which allow them to check a borrower’s rental history, utility payments and other bills payments.
According to those who support the practice, access to more information allows the lender to assess one’s creditworthiness better.
On the other hand, consumer groups opposed saying that many borrowers with non-stellar credit have low income which makes them unable to pay their bills on time. Including information on bills payment could worsen a borrower’s credit.
A staff attorney from the National Consumer Law Center told the Washington Post that consumers with minimal income often pay their bills late as certain issues cause the delay.
GM Financial has started using a credit scoring system based on rental history, utility payments and other nontraditional data.
According to GM Financial’s chief credit and risk officer, Steve Bowman, the new system allows them to approve credit applications that could be declined if only the traditional data from the credit bureaus were used. They can lower the interest rate by as much as 2 percentage points by having a wider scope of borrower information.
The subprime market in the auto lending industry demonstrated remarkable growth in the first three months of this year. Subprime auto loans rose by 8.4 percent while auto loans made to borrowers with good credit fell by 2.5 percent based on data released by Experian Automotive.
Further, subprime auto loans made up more than 35 percent of the total amount in outstanding auto loans in Q1 2013. It is short of the almost 40-percent figure in 2009 but it still indicates that the market is recovering—something that concerns consumer advocates.
Another staff attorney from the National Consumer Law Center told the Washington Post, “We want to see more lending, but not at the expense of consumers.”
He said that some lenders are extending auto loans up to 72 months which makes the monthly payment more affordable. However, the car may not have much value by the time the loan ends.
The growing demand for auto loans underpinned by auto loans made to people with less-than-perfect credit has partly contributed to the market’s growth. It tightened the competition among lenders as the securities are deemed as lucrative and safe.
However, the latest data from TransUnion showed a slight increase in delinquency rates. The rate in the first quarter is 5.5 percent, higher as compared to 5.1 percent in the same period last year.
TransUnion Vice President of automotive Peter Turek said, “While the auto loan market has been performing exceptionally well the last few years, there is some concern about the subprime market.”
There are a number of challenges that the widespread adoption of nontraditional borrower information sources face. For one, many lenders are still reluctant to invest in a potentially lucrative market. They are also concerned about clashing with federal regulations.
Meanwhile, larger auto lenders, which are under the oversight of the Consumer Financial Protection Bureau (CFPB), are worried about the repercussions of adopting such novel practice.
The CFPB this year fined a major lender for alleged deceptive practices. It also placed credit bureaus under their scrutiny after finding that one in four consumers receive scores that are different from the ones used by lenders.
Consumer advocates are concerned about the lack of transparency among credit-reporting agencies. They say borrowers are unlikely to find about the discrepancies prior to applying for a loan. Borrowers may not also be aware that the information about their utility and bills payments are being used to assess their likelihood of getting a car loan.
All firms that sell consumer information for credit decision purposes must be subject to federal laws. However, the rules largely apply only to firms with nationwide operation. Many firms are anonymous to consumers and under the radar of federal supervision.