The process of underwriting customer loans has changed over the years due to internal and external influences. Within the industry, new technology has been developed to enhance and simplify the process, while changing customer demographics and market conditions have required an adaptation of business models.
Dealers have also evolved by being more selective about where deals are sent and by becoming more knowledgeable about tier pricing. The growing importance of conversion rates among lenders is another factor for dealers to consider.
Shifting to Tier Pricing
A major shift in underwriting came about with the greater reliance on credit bureau scores to evaluate a customer’s creditworthiness. The FICO score, developed by Fair Issac Corp., rates all consumers on the same factors, such as late payments, bankruptcies and credit used versus credit available.
According to Experian, one of the three major credit bureaus in the United States, this generic scoring is superior to custom scoring done by each lender because it is less time consuming and limits the chance of subjective judgments. Prior to the FICO score, lenders manually looked over each applicant’s credit report and could decide to deny credit based on personal judgments about a person’s current debt or number of recent late payments.
Internal scoring is still used, often as a supplement to the bureaus. Individual lenders may choose to consider things such as a consumer’s homeowner status or length of employment in addition to bureau data.
Credit reports are also a useful tool in the fight against fraud and identity theft. This is a new concern on such a large scale and requires diligence on the part of dealers and lenders.
The use of standardized credit evaluations in loan decisioning gave rise to tier pricing in the car buying industry. Prior to this, indirect lenders offered one price for everyone, explains Tom Born, national underwriting manager of National City Bank, headquartered in Cleveland. “Some lenders would buy very tightly and wouldn’t put on a lot of riskier assets, so they would have very low prices and low losses.”
Today, tier pricing has opened the market to a broader range of consumers. Lenders are better able to finance individuals with less desirable credit histories without the disadvantage of having to offer the same low price for a higher risk just to stay competitive.
Attention to Conversion Rates
Lenders’ stressing of high look-to-book ratios have discouraged the practice of shotgunning — sending one application to multiple lenders at the same time.
Dealers now have to give some consideration to the type of customer they are working with and make an educated decision about which lender to contact.
“When I talk to dealers, they immediately say, ‘Well, his score is 650 or 720 …’ They know exactly what the bureau score is because that is how they determine which lender to send the deal to,” Born says.
As a dealer, you should strive to develop a good working relationship with your lenders so they will be more willing to work with you on borderline cases. If you consistently send deals that are appropriately targeted and made easy for the lender, you will also reap the rewards. In addition, your customers will be happier because there will be fewer rejections, in turn, creating a faster financing process.
The increased emphasis on conversion rates is due in part to competitive pressures facing lenders. Credit unions have become more aggressive in the indirect lending market and now go beyond serving just their members. Some operate like any other lender and solicit deals from dealerships in their region.
Captive finance companies have always been able to capture a large percentage of deals due to vehicle incentives. Taken a step further, some now offer direct incentives to customers just to finance through them.
“This is kind of a new twist,” Born says. “It’s had a real impact on most auto-lending banks that obviously can’t do something like that.”
Stretching Rate Terms
Customers with negative equity — considered “upside down” — are only getting more common as rate terms are extended even longer. A 72-month loan, once unheard of, is now an industry norm. Some lenders are even going as high as 84 and 96 months.
Dan Hills, director of Auto One Prime Operations, a division of Auto One Acceptance Corp. in Dallas, says it is unlikely his company would begin offering such long terms, despite a few requests from dealers.
“These types of trends are often started, but I just don’t see it catching on everywhere,” Hills says. “It’s just not the best thing for consumers.”
Born adds that it simply comes down to the average life of cars and not being able to extend beyond this limit. “To keep payments down, you either extend the terms or go back toward leasing. But every time you lengthen the terms, you get people more upside down in vehicles.”
With used-car values improving, Born says there could be a shift toward leasing to help consumers get out of debt.
As with many procedures, technology has played a significant role in how underwriting loans is done.
Gone are the days of faxing applications to credit centers where the data is manually keyed. Today, automated application entry has become an industry standard.
“When dealerships can do the data entry themselves, it’s a little bit faster,” Born says. “It also gives them a kind of warehouse where they can have data and some reporting can come out of that.”
Windows-based origination systems have also helped to speed training and ease of use, says Frank Armstrong, senior vice president of World Omni Financial Corp. in Deerfield Beach, Fla. “Additionally, being able to run a system in an ASP (application service provider) environment saves the cost of having your own IT department.”
Armstrong adds that the goals of World Omni’s future underwriting technologies are to provide more consistent, faster decisioning and enhanced offerings through robust and rich analytics.
Many indirect lenders have similar objectives. National City Bank’s Born says, “We’ve been getting more and more astute at system decisioning, and trying to get an instant decision back to the dealership, whether it’s an approval or a decline. That’s something everyone tries to do better all the time.”
Although e-contracting is still a relatively new concept for dealers, the general consensus is that it will be widely adopted in coming months and years.
The ability to generate and store electronic contracts instead of paper and the capability of submitting e-contract packages to lenders for funding is going to be too good to pass up.