CFPB report looks at differences in subprime auto loans provided by different types of lenders

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In a new Data Point report, “Subprime Auto Loan Outcomes by Lender Type,” the CFPB looks at how interest rates and default risk vary across different types of subprime lenders, and how much of the variation in interest rates among subprime loans can be explained by differences in default rates.  The CFPB generally concluded that subprime borrowers pay different interest rates depending upon the type of lender they use to finance their vehicle purchase.  For purposes of the report, a subprime auto loan is defined as one made to a consumer with a credit score of 620 or less.

The report places lenders into five categories: banks, credit unions, finance companies, captives, and buy-here-pay-here (BHPH) car dealerships.  The Bureau’s main findings are:

  • Bank and credit union subprime borrowers tend to have higher credit scores than finance company and BHPH dealership subprime borrowers and the value of vehicles financed by bank and credit union subprime loans tends to be higher than the value of vehicles financed by finance company and BHPH dealership subprime loans.
  • Average interest rates vary significantly across different types of lenders, with average interest rates of about 10 percent on bank subprime loans as compared to 15 to 20 percent on finance company and BHPH dealership subprime loans.
  • Default rates are higher at lender types that charge higher interest rates, with a 15 percent likelihood of a bank subprime loan becoming at least 60 days delinquent within 3 years as compared with a 25 to 40 percent likelihood for a  finance company or BHPH dealership subprime loan.
  • Differences in delinquency risk across lender types cannot fully explain the differences in interest rates across lender types. Small BHPH dealership borrowers had default rates comparable to bank and credit union borrowers and small finance company and large BHPH dealership borrowers had default rates comparable to large finance company borrowers.  However, interest rates charged to small BHPH dealership borrowers were substantially higher than rates charged to similar bank and credit union borrowers and interest rates charged to small finance company and large BHPH dealership borrowers were substantially higher than rates charged to similar large finance company borrowers.  (The Bureau’s “small” and “large” designations are tied to market share.)

The Bureau offers various possible explanations for why differences in default risk do not fully explain differences in interest rates charged by different types of lenders.  Those explanations include (1) a given level of default posing a greater risk to the profits of certain types of lenders because their loans are secured by less valuable vehicles or their costs of repossession and collection are higher, (2) underwriting practices of certain types of lenders that do not identify less risky borrowers and the use of technologies by certain lenders that reduce costs when consumers default while raising the cost of loans made to less risky borrowers, (3) perceptions about borrower sophistication that reduce incentives to offer lower interest rates to less risky borrowers, and (4) access to cheaper funding that allows lower interest rates to be offered to all borrowers.

The Bureau notes various limitations to the information provided in the report, including that while it looks at interest rates and delinquency outcomes, it does not observe many other potentially relevant factors such as how fees paid by borrowers to obtain loans vary across lender types and other loan characteristics such as the willingness of borrowers to pay an interest rate premium to reduce the chances of being denied a loan.  The Bureau concludes its report with a call “for more research on auto loan borrowers’ objectives, how they shop for auto loans, and how their objectives and shopping behavior influence borrower and loan outcomes.”

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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