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Universal Default's Snare on Car Buyers

September 2008, F&I and Showroom - Feature

by Steven Palmieri

Credit card companies have employed universal default as a way to ensure the terms of the credit match the current risk, but does this risk-evaluation tool tell the consumer’s full story? Understanding universal default may not only help get your next customer financed, but it will provide a better understanding of the market forces impacting today’s credit-challenged customers.

It doesn’t take much for an individual to fall into universal default. A one-time financial hardship is all it takes for a consumer to experience the financial avalanche that comes with the universal-default tag. What dealers need to remember is the actual credit worthiness of a customer who falls into universal default may be significantly higher than his or her credit profile indicates. Understanding this can be the difference between rehashing a deal and letting the customer walk.

In a typical car deal, the lender only analyzes the customer’s creditworthiness one time before the loan is approved. The lender will not periodically re-evaluate the customer’s creditworthiness because an auto loan is a closed-ended contract and the terms of the

loan are fixed.

Universal default refers to a specific type of default on an open-ended credit account (i.e., credit card), that has variable loan terms. The credit loan (or credit limit), as well as the credit

balance can increase or decrease. Because of this, the customer’s creditworthiness must be continuously updated to ensure that the

terms of the credit match the current risk. Lenders or creditors often times do a type of inquiry called a “soft pull” of credit, which doesn’t show up when a dealer pulls the credit report. The soft pull does not affect the scoring model’s calculation, but the results

of the soft pull may have potential adverse action on the credit account.

When a customer is considered higher risk or in default on a financial obligation with a lender or creditor, another creditor may place him or her into universal default. With this type of default a creditor has the option of changing the terms of a customer’s credit from “normal” to “default,” even if the customer’s account is current. Section 127 of the Truth in Lending Act does not prohibit such adverse

actions, so universal default is often disclosed by the lender under the default clause of a credit card application. Customers who do not read the terms of a credit card application before signing up for credit are often unaware universal default exists.

A customer who has several charged up credit cards can also be considered a higher risk even if the minimum monthly payments are paid. FICO’s empirical mathematical model calculates 30 percent of a

credit score based on the credit profile’s debt ratio. A recent increase in the debt ratio of the customer’s credit profile can

have a negative effect on the score. Under the terms of universal default, this drop in score may be enough for the creditor to put the customer in default.

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