In a new Data Point report, “Subprime Auto Loan Results by Lender Type, ”The CFPB looks at how interest rates and default risk vary among 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 high-risk borrowers pay different interest rates depending on the type of lender they use to finance their vehicle purchase. For reporting purposes, a subprime auto loan is defined as one made to a consumer with a credit score of 620 or less.
The report classifies lenders into five categories: Banks, Credit Unions, Finance Companies, Captives, and Auto Dealers Buy Here Pay Here (BHPH). The main findings of the Office are:
- Subprime borrowers from banks and credit unions tend to have higher credit scores than subprime borrowers from finance companies and BHPH dealers, and the value of vehicles financed by subprime loans from banks and credit unions tends to be higher than the value of subprime financed vehicles from finance companies and dealerships of BHPH loans.
- Average interest rates vary significantly between different types of lenders, with average interest rates of around 10 percent on high-risk bank loans compared to 15 to 20 percent on high-risk loans from finance companies and dealerships. BHPH.
- Default rates are higher for the types of lenders that charge higher interest rates, with a 15 percent probability that a subprime bank loan is at least 60 days past due within 3 years compared to a probability of 25 to 40 percent for a subprime loan from a BHPH dealer or finance company.
- Differences in delinquency risk between types of lenders cannot fully explain differences in interest rates between types of lenders. Borrowers from small BHPH dealers had default rates comparable to borrowers from banks and credit unions, and borrowers from small financial companies and large BHPH dealers had default rates comparable to borrowers from large financial companies . However, the interest rates charged to borrowers from BHPH’s small dealerships were substantially higher than the rates charged to borrowers from similar banks and credit unions and the interest rates charged to small finance companies and borrowers from large BHPH dealerships were substantially higher than the rates charged to borrowers from similar large financial companies. (The Office “small” and “large” designations are tied to market share).
The Bureau offers several 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 that poses a higher risk to the earnings of certain types of lenders because their loans are secured by less valuable vehicles or their recovery and collection costs are higher, (2) underwriting practices of certain types of lenders that do not identify the least risky borrowers and the use of technologies by certain lenders that reduce costs when consumers default while increasing the cost of loans made to less risky borrowers, (3 ) perceptions of borrower sophistication that reduce incentives to offer lower interest rates to less risky borrowers, and (4) access to cheaper financing that allows lower interest rates to be offered to all borrowers.
The Office notes several limitations to the information provided in the report, including that while it looks at interest rates and delinquency results, it does not look at many other potentially relevant factors, such as how fees paid by borrowers for Borrowing varies between the types of lenders 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 the goals of auto loan borrowers, how they purchase auto loans, and how their purchasing goals and behavior influence borrower and loan outcomes.”