The automotive lending industry is facing a unique convergence of challenges, including tightened lending conditions, reduced credit availability, and historically high vehicle prices. Despite these obstacles, emerging Lending Enablement Solutions are helping financial institutions expand their borrower base, increase loan volume, and improve return on assets (ROA) while mitigating risk.
These solutions are providing automotive lenders with faster decisioning speed, AI-driven data analysis and risk modeling, and personalized pricing. Lending Enablement Solutions also allow financial institutions to identify more creditworthy near-prime borrowers. Near-prime loans offer automotive lenders a competitive advantage and an opportunity to serve an overlooked segment at a time when access to an automotive loan is critical to their livelihood.
Continued Challenges in the Automotive Lending Industry
According to Automotive News, 39% of banks polled in the Federal Reserve’s Loan Officer survey expect to tighten lending before the end of 2023. Piling on to this general tightening, 29% of banks had already constricted their auto loan standards between January and March of 2023.
And borrowers are feeling the pressure from these changes to loan standards. With tightening credit access across lending and the credit approval rate down 2.4 percentage points year-over-year in May, borrowers are struggling to get loans, according to Cox Automotive.
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Reduced borrower eligibility means financial institutions face a shrinking borrower pool and loan volumes. According to TransUnion, the average monthly payment for a new car has increased by approximately 26% in two years (from $585 to $736 in the first quarter of 2023). The average monthly payment for used cars reached $523, up $110 over the same period. These increasing costs and more restrictive lending standards are contributing to vehicle unaffordability, especially among near-prime borrowers.
According to the Edmunds Used Vehicle Report, the share of used vehicles sold for under $20,000 was 30.6% in the first quarter of 2023 compared to 60.5% five years prior. In the new car market, less than 1% of vehicles sold during the same time were under $20,000. Financial institutions have an opportunity to effectively serve customers and develop long-term loyalty by offering personalized, affordable loans.
Financial institutions are being conservative to the point that they risk customer relationships and their bottom line. Rather than exploring technological solutions to continue serving borrowers, they are pulling out of lending channels and segments altogether. Recently, Citizens Financial stopped offering lending through dealerships to reduce risk exposure. Citizens and others are closing indirect automotive loan portfolios to try to cut auto loan origination volume. Although lenders may minimize risk by doing this, they are also closing off potentially profitable loans.
Additionally, meeting your customers where they are is a foundational business principle. Financial institutions that shutter borrowers’ preferred lending avenues will likely impact customer relationships and reduce the likelihood that they’ll return for other services. This approach may also counter their own compliance efforts related to CRA and fair lending regulations.
Lending Enablement Solutions Can Help
Lending Enablement Solutions equip automotive lenders to face market challenges by analyzing risk through alternative credit data, providing automated decisioning, and improving ROA. They help mitigate risk by identifying previously overlooked borrowers or offering default protection. Having the added benefit of high-quality loan default insurance to absorb potential deficiency balances gives automotive lenders greater confidence and security to increase loan origination volume. While safeguards are necessary, it is critical to intelligently evaluate borrowers’ creditworthiness before extending loans.
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Alternative Credit Data
Identifying a borrower’s creditworthiness requires leveraging alternative data beyond typical FICO scores. Traditional underwriting models that consider FICO scores alongside income, employment history, and debt-to-income ratio often overlook many applicants because they evaluate borrowers with a limited scope. FICO scores are critical. But when evaluated alone or overprioritized, they are insufficient to score, price, structure, and decision an automotive loan.
By including and considering alternative data (e.g., rental history, mobile phone payments, and account balances) automotive lenders gain a more holistic and accurate borrower profile. Relying on reductive datasets prevents automotive lenders from reaching more deserving borrowers, diversifying their portfolios, and identifying potentially profitable loans.
According to Experian’s Q1 2023 State of the Automotive Finance Market Report, the near-prime borrower audience has fallen to 17.59% of total financing from 18.46% in 2022, illustrating the growing challenge for them to receive auto loans.
Near-prime customers who traditional financial institutions may overlook can have their creditworthiness more accurately evaluated. With this renewed lens for qualification, lenders can safely increase loan volume and reach more underserved customers.
AI-powered Decisioning
Slow decisioning speed is a top challenge facing automotive lenders. In today’s competitive market and with the proliferation of AI-powered solutions, automotive lenders are expected to move fast. Consumers and automotive retailers have come to accept nothing less. However, automated decisioning should not sacrifice safety for speed. Identifying solutions that can quickly and accurately ascertain a borrower’s risk profile is essential for building profitable portfolios.
Improving the Automotive Lending Industry
Lending Enablement Solutions are essential in empowering automotive lenders to expand loan volumes, accelerate the decisioning process, and enhance the borrower experience. Financial institutions that partner with fintechs to implement these tools are far better prepared to adapt to changing market conditions, increase ROA, and remain competitive in an increasingly digitized lending landscape.
Not all Lending Enablement Solutions are created equal. It’s essential to look for providers with a proven track record of using sophisticated analytics to manage risk at loan origination and in the case of potential default. Evaluate case studies and consider how other financial institutions used the solution to grow their loan portfolio tangibly while mitigating risk.
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