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Navigating High Rates And Shrinking Liquidity


The high cost of vehicles combined with rising interest rates is creating the perfect storm and making it very hard for many consumers to afford a reliable vehicle. Borrowers are experiencing not only sticker shock but also payment shock.

Conventional loan payments have risen by 29% since March of 2020, according to Cox Automotive. In its predictions for 2023, Cox says vehicle affordability will be the greatest challenge facing vehicle buyers. Almost 17% of people financing a new vehicle in the first quarter of 2023 signed up for a loan with a monthly payment surpassing $1,000.

According to Edmunds, the average annual percentage rate on new financed vehicles rose to 7% in the first quarter of 2023 from 4.4% in the same quarter of the previous year. A one-percentage-point increase can add approximately $20 to the monthly payment and thousands of dollars over the life of a loan.

Some borrowers are resorting to extending terms to deal with the overall high cost of financing a vehicle. Experian reports that in the third quarter of 2018, only 11% of new vehicle and 4.1% of used vehicle borrowers had loans with a term of 84 months. In contrast, by the third quarter of 2022, these percentages had grown to 19% for new vehicle and 11% for used vehicle loans.

Long loan terms carry many risks for consumers and lenders. Most prominently, they can create a cycle of negative equity that a borrower might not be able to get out of, increasing the risk of default for the lender.

Credit Unions And The Liquidity Crunch

Credit unions are facing their own headwinds and are currently staring down a liquidity crunch. During the pandemic, deposits grew at unprecedented rates due to a mix of reduced consumer spending and stimulus funds provided by the government.

But as restrictions lifted and stimulus programs ended, savings rates declined and consumers had to dip into their savings to manage the higher cost of goods in an environment of rampant inflation.

With dwindling liquidity and higher cost of borrowing, credit unions have tightened credit. However, pulling back on auto lending could have negative consequences for credit unions in the long term. Auto loans have historically been a reliable source of income and growth for credit unions, and reducing lending in this area could result in slower growth and fewer new members in the future.

Many consumers have traditionally chosen credit unions over other financial institutions specifically because of their competitive rates on auto loans, but currently they are finding the search for a lower rate is fruitless, so they are becoming payment shoppers.

How Credit Unions Can Navigate The Crisis

Credit unions are at a difficult crossroads where they have to balance the need for affordability and serving the financial needs of their members with their need to remain profitable to guarantee continuous operation.

One opportunity to manage this quandary is to look at residual-based vehicle financing — walk-away balloon lending and vehicle leasing.

One of the advantages of residual-based financing is that the credit union can offer members a lower payment alternative, regardless of the vehicle cost or the rate compared to a conventional loan.

Another advantage of this type of financing is that borrowers can generally get a more affordable payment with a shorter term. This significantly reduces the risk that members will wind up owing more than their vehicle is worth and end up trapped in a negative equity spiral.

From the credit union’s perspective, this loan type earns a higher yield because the loan amortizes to the residual value, producing higher average daily balances. In an environment where a credit union’s ability to lend funds is more limited, offering this option can produce a greater return and help boost the credit union’s profitability.

Tim Kelly is the president of  Auto Financial Group. Kelly has more than 20 years’ experience delivering solutions to financial institutions. Contact him at tkelly@autofinancialgroup.com.

Auto Financial Group (AFG), a Houston-based company, provides an online, residual based, walk-away vehicle financing product called AFG Balloon Lending, as well as vehicle leasing and vehicle remarketing to financial institutions across the United States. For more information about AFG call toll free at 877-354-4234, or visit www.autofinancialgroup.com.

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