Federal Credit Union executive talks higher interest rates, looming delinquencies, and other risks before auto lenders.
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There’s no question auto rates have inched upward but how fast and how far they climb remains to be seen, says Michael C. Borman, vice president/chief lending officer at JetStream Federal Credit Union. He explains people mistakenly believe auto rates are tied to what the Federal Reserve does with the prime rate. So, when the Federal Reserve raises the prime rate, they mistakenly believe auto rates will go up in kind.
The Federal Reserve increased the prime rate by 2.25 basis points over the last four months and prime rate now stands at 5.5. But that’s not what has happened with auto rates, he says. In fact, JetStream has increased its rates by just .25 basis points in the time frame that the Federal Reserve raised the prime rate 2.25 basis points.
“The Federal Reserve’s actions impact loans tied to the prime rate, like credit cards, which have variable interest rates, or home equity lines of credit,” he says. “[For auto loans], we monitor the competitive landscape quarterly to determine if our rates are competitive. Then we adjust our rates as needed.”
Lenders also tie auto loan rates to the type of vehicle and the consumer itself. For instance, a new vehicle has a lower interest rate than a used vehicle. The borrower’s credit and their capacity to pay also factors in. The loan-to-value ratio also applies. The lower the loan-to-value ratio, the lower the risk, and the lower the interest rate. Whereas higher loan-to-value ratios come with higher interest rates.
“In the credit union space, we also have what we call relationship pricing,” he says. “If you have a relationship with us, then you can get discounted rates.”
But as Borman looks out further, he predicts auto loan rate hikes on the horizon. “They predict the Federal Reserve will raise the prime rate 50 to 75 basis points next month,” he says. “Auto lenders also will move up their rates. JetStream will as well. We want to be competitive. But we also must adjust rates as the market and the competition adjusts theirs.”
Higher Than Ever Payments
Alarm bells are sounding industry wide over higher-than-ever car payments driven by record prices, Borman adds.
“We have many people buying $60,000 to $70,000 vehicles,” he says. “In our portfolio, the average payment on a new car loan is $650. For a used auto, the average payment has hit $550. We also see people taking on longer terms. We once considered 72 months a long-term loan. Now people finance automobiles out to 84 months.”
JetStream’s numbers are slightly lower than those posted by Cox Automotive in July. According to the retail analyst, the average monthly payment for a new car reached a record $733 in July, up 0.9% from June and up 15% from the same time period in 2021.
Edmunds research shows an even bleaker picture, where 12.7% of car buyers financing new vehicles in June committed to payments over $1,000. This is the highest payment Edmunds has ever recorded. The average amount financed also hit near record levels at $40,602 in the second quarter, according to Edmunds.
Cox Automotive cites record vehicle prices as the reason for this trend. The average transaction price for a new car hit $48,182 in July, up 0.3% from June.
Higher transaction prices and bigger loans pose an elevated risk to lenders and consumers. If record vehicle values slip, consumers risk being upside down in their loans. “That’s a huge concern for me. Right now, the loans we close are under a 100% loan-to-value ratio. We are not doing auto business above that 100% threshold. A big part of that is because of record values. If the economy starts to slip, auto values may drop. And they already are a depreciating asset,” he explains.
JetStream protects itself and consumers by offering GAP coverage and vehicle service contracts on every loan. “GAP or Guaranteed Asset Protection is very economical protection at $599,” he says. “If the vehicle gets totaled out and insurance doesn’t cover the full amount, GAP coverage comes into play and takes care of it. We strongly encourage all of our customers to add GAP coverage when it makes sense.”
He explains when consumers put down large down payments to come in at or below a 50% loan-to-value ratio, GAP makes little sense. But for those at the higher end, GAP coverage is a needed protection.
Down payments, he adds, remain high for higher-end vehicles (those with values at $80,000 to $90,000). But for vehicles less than $40,000, “we are not seeing huge down payments because the value of the vehicle is so strong,” he says.
Delinquency Trends
TransUnion recently sounded the alarm on delinquency rates, pointing out that auto loans taken in the second and third quarters of 2021 are returning to the delinquency rates of 2019. Their report suggests “pandemic score migration” is to blame. This term encompasses when a borrower was approved as a near prime consumer in 2020, but now behaves like a subprime consumer.
Borman sees things a little differently—at least at JetStream. “At our credit union, delinquency remains very low,” he says. “Last year, we reported $35,000 to $40,000 in delinquency. To put that in perspective, our loan portfolio is $50 million. It continues to be that way.”
However, Borman predicts delinquency will rise and acknowledges that JetStream has prepared for it. With a down economy, higher-than-ever loan payments, and other stressors, Borman sees a coming delinquency spike.
JetStream has beefed up its Member Solutions Department in response. “Lenders must make sure they are fully staffed, and possibly even over-staffed, so that if delinquency spikes, they can handle the workload,” he says.
Record High Consumer Debt
Consumer debt overall has hit record highs, he adds. The National Association of Federal Credit Unions reports that in June 2022, total household debt in the U.S. reached a record $16.15 trillion. Over 70% of that number represents mortgage debt, which Borman says is a good thing because it shows home ownership.
“But with inflation and skyrocketing costs for food and other goods, people are using their credit cards again and we are seeing an increase in home equity loans,” he says. “People are taking out home equity loans for debt consolidation, college tuition and emergency backup plans.”
Though debt levels have yet to reach pre-pandemic levels, Borman warns “with higher prices and additional debt, many consumers are going to get themselves into a position where it will become more difficult to meet their monthly obligations. I believe we’re going to see more auto loans go delinquent because of these factors.”
Knowing this, he adds lenders have a responsibility to beef up borrower’s financial literacy. “Responsible lenders educate borrowers on the loans they are applying for,” he says. “JetStream provides guidance and education. We will advise them if we feel they may put themselves into a risky situation where they cannot afford this auto. We may guide them toward a smaller automobile loan or different vehicle to get them into a new or used vehicle at a price they can afford.”
ABOUT THE AUTHOR: Ronnie Wendt is an editor for Auto Dealer Today.
