Lenders are loosening once-tight credit standards, giving Americans with limited or poor credit histories a better shot at buying a car but raising concerns among consumer advocates about their methods.
In the wake of the financial crisis, many lenders shied away from these borrowers. But as the economy bounces back and competition for borrowers with stellar credit intensifies, lenders are turning to credit-
challenged borrowers as another potential source of revenue.
That helped consumers snap up cars and trucks at a 15.6 million annual rate in July, about the same pace as in December 2007, when the recession began, and up from a low of 9 million in early 2009.
Yet the methods being used to make loans to those with less-than-perfect credit is making consumer groups leery.
Some lenders have begun to reach beyond the traditional credit bureaus — Equifax, Experian and TransUnion — to alternative data sources, including some that check a borrower’s utility payments and rental history, for information.
Advocates of alternative data say the added layer of information they provide makes the lender better able to assess the risk of the borrower.
“Including alternative data in the underwriting process increases credit access for lower-income persons, members of minority communities, and younger and older Americans,” said Michael Turner, president of the Political and Economic Research Council, an industry-research group.
Consumer groups counter that people with limited credit histories often are low-wage workers who may struggle to keep up with their bills. Reporting this sort of information could further impair their already shaky credit, said Chi Chi Wu, a staff attorney at the National Consumer Law Center.
“A lot of low-income consumers often pay their utilities late, especially in months when the costs are high. And sometimes people withhold their rent because of issues with their apartment,” she said. “Will these systems take any of that into account?”
One lender, GM Financial, signed up for LexisNexis’s RiskView, a credit score based on utility payments, rental history and other nontraditional data, three years ago as the auto market started to rebound.
“Using the RiskView score allows us to approve applications that would otherwise be declined if only traditional credit bureau data were used,” said Steve Bowman, GM Financial’s chief credit and risk officer.
By pulling a wider set of consumer data, GM Financial sometimes can lower the interest rate charged on a loan by 2 percentage points, Bowman said.
Although subprime loans represent a small fraction of the auto market, they are the fastest-growing segment. Subprime auto loans, those made to borrowers with credit scores below 680, climbed 8.4 percent in the first three months of the year, while car loans to borrowers with high credit scores slipped 2.5 percent, according to Experian Automotive.
Subprime auto loans accounted for 35.4 percent of the $726 billion in outstanding car loans in the first quarter. That is shy of 2009, when such loans comprised nearly 40 percent of the market, but an indication that the market is roaring back. And that worries consumer groups.
“We want to see more lending, but not at the expense of consumers,” said John Van Alst, a staff attorney at the National Consumer Law Center.
Auto dealers, he said, are extending the repayment periods of some subprime loans up to 72 months to make the monthly car note more affordable, but the length of the loan could exceed the useful life of the car.
“Part of what’s feeding the market is greater demand from Wall Street to securitize and sell these loans, which is creating increased competition for the dealers’ business among lenders,” Van Alst said.Private equity firms and other investors are snapping up securities underpinned by subprime car loans because the assets are viewed as safe and lucrative.
Auto loans performed well throughout the recession. What’s more, average revenue from interest and late fees totals $9,400 per customer over the lifetime of a subprime loan, compared with $2,500 for a traditional loan, according to Javelin Strategy & Research.
To offset the risk of signing up borrowers with poor or limited credit, some subprime auto lenders charge annual interest rates above 10 percent.
Amid the resurgence of subprime auto lending, delinquency rates are inching up, according to data from TransUnion. About 5.5 percent of subprime auto borrowers were delinquent in the first quarter, compared with 5.1 percent during the same period last year, according to the firm.
“While the auto loan market has been performing exceptionally well the last few years, there is some concern about the subprime market,” Peter Turek, vice president of automotive for TransUnion, said in a statement.Widespread adoption of nontraditional data sources faces a series of challenges. Lenders remain hesitant to invest in an emerging industry and are concerned about running afoul of federal regulation, said Ankush Tewari, director of strategy and market planning at LexisNexis, which says about 20 auto lenders use its nontraditional information to determine creditworthiness.
Large auto lenders, which are subject to the supervision of the Consumer Financial Protection Bureau, are worried about the ramifications of using third-party providers, he said.
In June, the bureau fined U.S. Bank and one of its vendors $6.5 million for allegedly duping service members into paying for add-on products purchased with auto loans. Industry watchers consider the case a harbinger of things to come. The CFPB said it will continue to monitor the market.
Credit-reporting agencies also have come under greater scrutiny from the consumer bureau. In September, the bureau released a study that found that credit agencies provide as many as one in four consumers with scores that differ from those used by lenders.
The lack of transparency in the credit-reporting process troubles consumer advocates, who say borrowers are unlikely to know about any discrepancies until they are denied credit. There also is concern that borrowers may not be aware that their cellphone bills are being used to determine their eligibility for loans.
Any firm that sells data used in credit decisions, including alternative data providers, must adhere to federal laws meant to protect personal information that can influence consumers’ credit scores. However, the rules governing disclosures are limited to firms that operate nationwide.
“Unfortunately, many firms operate in the shadows and are widely unknown by consumers,” said Turner of the Political and Economic Research Council. “This is an area ripe for greater federal oversight.”