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The Steady Rise of the Auto Loan Industry

Tuesday, March 20, 2012 10:53am
Starting line
The news and other media sources have been heralding the auto loan industry as the current leader in the financing world. Reports of dropping interest rates, growing car loan originations, and fewer defaults have been causing the other financing sectors to look upon their vehicle-focused brother with sharp stares of envy. But what has caused the auto financing industry to take the lead in this race to success? Particularly after considering the state American car manufacturers were in just a few years ago, prompting the government to shell out billions of dollars to save them, it’s quite a surprise to see such a massive turnaround in such a short amount of time.

But the auto loan industry’s success comes from their willingness to adopt a practice that none of it contemporaries are willing to do: stray from the book.

Extreme Times…

One of the golden rules in lending is to minimize risk. The less risk a lender has in loaning his money to a borrower, the more likely he will make a profit off that borrower. In an effort to adhere to this golden rule, the financing world gained help from the creation of credit rating bureaus. The big three—Equifax, Experian, and TransUnion—all maintain records of every U.S. citizen who has any sort of financial history. Depending on that recorded history, borrowers are assigned a number representing their risk to lenders; the higher that number the better, with anything over 700 being regarded as “good.”

For years now the financing world has used prospective borrowers’ credit scores to determine their eligibility for loans. Those who were considered less risky received better interest rates. All things considered, better interest rates led to cheaper financing. As a result, those with good financial history were more apt to maintain that good financial history.

But then the nation’s housing market collapsed in 2007, and even the most credible of borrowers saw their most prized possession—their home—lose its value at a shocking rate. For millions of mortgage borrowers, the loss in value was so severe that their home financing became more expensive than the worth of their house, propelling their home into a state referred to as “underwater.”

Many of those who owned an underwater home began to contemplate the pros and cons of maintaining such a financially harmful asset. Some tried to hold onto their mortgage loan, telling themselves that this was their home, and they didn’t want to lose it. Others tried to continue paying based on moral grounds, feeling obligated to pay back a debt they promised to repay. But for still others—a group that grew to a far greater size than most economists would have dared to imagine—they walked away.

Walking away from a home loan meant doing exactly that: packing up one’s belongings and leaving, never to make another payment on their underwater property’s mortgage bill.

Naturally, the big three credit bureaus had their hands full as millions of homeowners began walking away from their home’s financing bills. Credit scores were slashed left and right, labeling a large portion of the population as “risky borrowers.”

The Untied States was left with a substantial amount of unqualified borrowers who were forced to rent their homes. They couldn’t obtain another home loan to buy, they couldn’t get an auto loan for a new vehicle, and they couldn’t qualify for a personal loan to weather the financial storm.

In tagging millions of previously credible borrowers as “unqualified,” the lending industry shot itself in the foot and began to fall into a slump due to a lack of business.

But then the auto loan industry opened its eyes.

…Call for Extreme Measures

Lenders everywhere closed their doors to everybody from the very wealthy business owner to the secure middleclass family man—but those in the car loan industry realized that they were just driving potential money away by doing so.

Straying from the typical and closing the “book,” auto loan originators took a step back and looked at reality. What they saw was a nation full of credible borrowers, despite what the big three was calling them. Due to the housing collapse, many qualified borrowers endured a freak financial occurrence, and as a result, suffered an enormous ding to their credit scores.

What’s more is many of these potential borrowers no longer had other debt obligations, such as a mortgage, and were actually in a better position to borrow than before the real estate collapse.

Car loan lenders soon found that their borrowers were actually becoming less and less delinquent, which in turn increased the lenders’ profit. Interest rates dropped (and appear to be continuing to drop), reaching a recent four-year record low that hadn’t been seen since right around the economic collapse.

And today, reports continue on an almost daily basis suggesting a steady and rising success rate for this industry.

Those who originate auto loans took a step back from their ivory tower and saw a time to innovate. They pushed aside the teachings of old and adapted to their current environment. Through critical analysis of the market place, the industry committed the likeness to a financial “moneyball” and deviated from what they had always known in an effort to accommodate these new and trying times. Because of their willingness to adapt, auto loan originators blasted off and now rule as the first place contender in the world of financing.

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