When rate is over-rated

Two customers head to their local car dealership on a Saturday. Daniel wants an SUV and has a credit score of 820. He’s received multiple credit solicitations. Dealer financing is optional for him. On a scale of 1-5, where do you think interest rate ranks on his list of most important factors? 

Rachel really needs a car, as her current car is at a volatile age. Her FICO score is 639 – below prime, but not subprime (defined as < FICO 620). Her credit history shows a solid record of making on-time car payments. Same question: where is she ranking that interest rate?

Answers: We probably all guessed that Daniel ranks interest rate at number one. And why not? He has multiple competing offers.  He’s prime and has options. 

Confession time: Rachel is a trick question. Interest rate doesn’t make her top five list. It comes in a distant sixth place. This fact surprises many traditional lenders. Getting to know Rachel and others like her, your next members, could change the way you look at auto lending.

What if I offered you a Rembrandt valued at $100 million? But I generously slash the price to $50 million. That’s an instant $50mm to your net worth. However great the offer, it’s not relevant if it is beyond your reach. This is what happens to so many non-prime borrowers—by far the largest share of the car-buying market. Low interest rates are great, but often out of reach. Let me explain.

More than a few credit union loan officers have reviewed a member’s dealer-based loan and thought they could have done better, meaning a lower rate. No one likes to see predatory rates on people who can least afford them.

But understanding that none of Rachel’s top 5 factors are interest rate helps the astute lender navigate the difference between predatory and possible.

1. Down Payment – how much today to drive away with a car?
   You’re about to see a recurring theme – cash flow. Post-COVID, 63% of consumers (146 million US adults) live paycheck-to-paycheck. If their current paycheck is allocated elsewhere, it makes sense that their #1 factor is money down. Credit union websites/media pounding the drumbeat of ‘low rates’ while ignoring near-term cash flow is wasted media. Boasting only of low rates is simply an executive team echoing back what’s important to them, not their next members. The old days of substantial down payments and shortened terms might as well be a $50 million Rembrandt to Rachel.
2. First Payment Date – when is the first payment due?
   I warned you – cash flow. Now that she has a new vehicle, she needs to re-arrange the chips to make the payment. 45 or 60 day first payments are very appealing to Rachel.
3. Monthly Payment – can I allocate this much?
   No surprise here except perhaps that many lenders assume monthly payment is higher than #3. Pop quiz: what lowers a monthly payment more – lowering the interest rate by 400 bps (4.00%)? or extending the term by 12 months? It’s B, and it’s not even close. A loan officer who thinks his 7.50% rate at 60 months is SO MUCH more appealing than the dealership’s 11.50% rate for 72 months is only thinking about Daniel and doesn’t understand Rachel’s needs. Did we mention cash flow matters?
4. Negative Equity – am I or will I be upside down?
   Does your credit union have an auto lending solution for current or future negative equity? I can assure you that your local car dealer does. Why do 84% of all car loans occur at dealerships, not at financial institution branches? Dealerships address consumer problems. And for 163 million US adults, interest rate isn’t high on their list of problems.
5. Reliability/Warranty – will I have an unaffordable repair?
   Rachel needs her car to live. There are two things she cannot afford: 1) a major repair, and 2) sidelining her car because she’s unable to pay for a major repair. The peace of mind that comes from a warranty lets Rachel know she can always get to/from her job—a job more likely to be service-related while Daniel parks his SUV all week working from home on his tech job.

In a market crowded with prime and captive lenders, interest rate is a commodity, not a mission.

Predatory lenders design products for those with credit below 550, then they reach up and grab Rachel and pull her down with them. Offering solutions to Rachel, with appropriate increased pricing, is auto lending’s greatest growth opportunity. It serves your mission and adds substantially more yield to your bottom line. Does your website talk about:

• no money down
• delayed first payment
• low monthly payments
• negative equity solutions
• protection against repair bills?

If anyone is speaking to Rachel, shouldn’t it be credit unions? And shouldn’t they be the best at it?

Low interest rates? The consumer crowd chants in unison: “Oh-ver-rate-ed clap…clap…clap clap clap”.