By John Flynn, CEO, Open Lending
The Wall Street Journal recently featured an article, A $45,000 Loan for a $27,000 Ride, which discusses how rising car prices and consumer trade ins are causing some to damage their financial well-being. Let’s do our borrowers and ourselves a favor by following the data.
Open Lending has followed a few guidelines in our lending. These are not arbitrary; they represent what the data tell us. Financial institutions can protect themselves and their borrowers by keeping these things in mind:
While the article points to car loans extending out more than seven years, that’s really not advisable for anyone. Particularly with indirect lending, the maximum loan term should be around 72 months. It may seem like just another year, but that additional 12 months exacerbates the negative equity in the first couple of years. Then, if they need to trade in the vehicle, the borrower still owes on the old car and the new one.
Which also leads to negative equity on the new vehicle on top of the decline in value after driving it off the lot. Limiting your borrower loan-to-value to less than 145% will help keep borrowers afloat the rollovers in your portfolio at bay. One borrower mentioned in the WSJ article was up to 166%!
Finally, mind the mileage. Especially with a high loan-to-value or longer-term loan, the mileage is critical in calculating your risk as the lender, as well as steering borrowers toward options that might be a better fit. For example, if a vehicle has 150,000 miles on it, it would be prudent of the lenders to limit the term to 48 months to help reduce the negative equity early in the loan. This protects both the lender from risk of that vehicle breaking down entirely and the borrower walking away, plus the borrower isn’t stuck with a loan when they no longer have a vehicle.
High-mileage vehicles and long terms can lead to potentially hazardous financial conditions for borrowers down the road. It can lead to more write offs for the lender and snowballing loan burden for your borrowers. By limiting rollovers, keeping terms reasonably tight and pricing accordingly for higher mileage, used cars and trucks, lenders and borrowers can both feel more at ease with the decisions they’re making. Want to feel even more secure in your auto lending decisions?