Avoid the Subprime Mess

Get ready for a wild ride. The mortgage meltdown quickly is spreading into auto finance, with lenders seeing many of the same problems that are infecting the housing market. The signs are similar wildly inflated values, financing vehicles for more than they are worth, providing generous terms for customers with marginal or poor credit while demanding little or no money down. And as with mortgages,

Get ready for a wild ride. The mortgage meltdown quickly is spreading into auto finance, with lenders seeing many of the same problems that are infecting the housing market.

The signs are similar — wildly inflated values, financing vehicles for more than they are worth, providing generous terms for customers with marginal or poor credit while demanding little or no money down.

And as with mortgages, lenders are reacting in a predictable manner- tightening standards and reevaluating dealer relationships.

You might be thinking, “Come on Bryan, we've seen this before.”

True, but in many ways, this contraction promises to be far more painful to finance providers than past slow-downs. Customers continue trading out of ever extending loan terms at the same favorable rates, but the negative equity in many transactions continues to accumulate.

Although consumers are over-leveraged with a virtual negative savings rate, down payments have generally not been required to off-set these increases. The net effect is more consumers are further upside down in longer and longer loan terms. Their investment in their vehicle and incentive to stay in it is minimal.

It's a downward spiral. Industry stories of tripling of delinquencies at lenders are common, which usually means repossessions will soon follow. This further puts pressure on used-vehicle values and increases the negative equity a consumer is facing.

Now, we are hearing stories of consumers walking away from their loans after making three years of payments — and that just never happened in the past.

Lenders recently have started extending loan terms to an unbelievable 84 months. It's a way to get marginal credit bought with payments that are digestible to the customer (while including all of the F&I products possible).

The problem is, in the past the consumer might have had a year or two left to go on their loans, but with 84 month terms more common today, consumers might have four or five years of remaining payments. The decision to give the car back is far easier.

As a result, some sub-prime lenders are for sale and others may be soon. Many other lenders are retrenching by cutting off poor performing dealerships, raising minimum FICO levels, and reducing overall credit risk. This further puts pressure on dealers, and makes selling cars in a tough market even more challenging.

But there are some anticipatory steps dealers can take to address what is happening in the market.

  • Meet at a senior level with your primary lenders, including the captive, national banks and sub prime lenders. Work to strengthen the relationship so that if there are problems that arise there can be conversations to address the issues rather than being abruptly cut-off.
  • Look for alternative lending sources. There are still many regional financing sources that are operating and some are moving in to fill the void left by the national lenders cutting back. It may take some effort learn their programs, but sitting still with existing lenders is likely not a viable option.
  • Take advantage of the depressed used vehicle market to source inexpensive vehicles where an equity position might be achievable with a minimum down payment.
  • Re-embrace leasing. Train the sales staff and managers on the concept. It's still an excellent tool for delivering lower payments and unburying negative equity. For the dealership, its remains one of the best loyalty options available.

As with past credit consolidations, this situation will likely pass as well. The Federal Reserve has already reduced target rates and has pumped liquidity into the financial system. But for some lenders the damage might be too much to overcome, and dealers will face the fall-out. Proactively working to address these problems is the right approach for dealers to take.

F&I consultant Bryan Dorfler works with dealerships, lenders and aftermarket providers nationwide. He is at [email protected].

Questions or comments about this column? Send us an e-mail at [email protected].

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