When you decide to expand your institution’s growth potential by moving into nonprime auto lending, you not only gain access to the 42% of adults with a nonprime credit score, you also potentially expose your institution to increased default risks. As with any opportunity, managing the risks in order to get the rewards is vital, which is why you need a loan origination system (LOS) incorporating risk mitigation tools that reduce the added risks of nonprime lending. How can an LOS do all that? Let’s take a look.
Why Your LOS Matters
While lending to nonprime markets, a lender’s number one advantage is information. Lenders increasingly look outside FICO’s narrow confines and incorporate a more rigorous underwriting process with alternative data. Alternative data is becoming so important to lenders that in Experian’s 2018 report about alternative data and the loan life cycle, they found that 80% of lenders relied at least in part on alternative data to make credit decisions.
It’s up to your LOS to help you manage incoming alternative data efficiently. Not only does it need to do so through streamlined communication with third-party data providers but it also must accommodate a more sophisticated risk model and rules engine, allowing for fast, automated decisions using this expanded data.
Your LOS is a treasure trove of information hidden within the historical data collected from the loan applications you have decisioned. Does your LOS give you the tools to discover important insights? As you analyze your lending data, you may find there are other factors that indicate increased or decreased risks for potential borrowers. For example, it’s possible that employees of a certain company will show they are far less likely to default on loans. You may also find that borrowers funneled through specific dealerships have more or less likelihood of default.
Reducing Risk With Risk-Based Pricing
Risk-based pricing is another method of tempering the risks taken on by nonprime lending, but many institutions don’t realize they can price individual loans based on factors beyond credit score. For example, an institution can consider the severity of defaults rather than just the probability of default, thus retooling their portfolio to reduce the severity of risk and potentially drive up profits.
Other factors to consider in risk-based pricing include the term of the loan being requested, loan-to-value on the vehicle, the applicant’s credit depth, whether the vehicle is new or used, the make and model to determine depreciation on the asset and geographic location.
Beyond setting more personalized loan rates, risk-based pricing can:
● Provide accurate pricing to help offset write-offs and gain competitive advantage;
● Allow credit unions and banks to offer services to a wider range of members;
● Produce higher yields on nonprime loans and a higher volume of loans without slashing rates; and
● Create a more diverse portfolio.
Rounding Out Risk Reduction
When it comes to subprime lending, the ideal LOS is one that will allow you to automate with nuance. For example, you might use an LOS that runs real-time performance reports containing dealer-specific loans, application, funding, acceptance and decision status summaries, enabling you to better analyze origination channel and employer and data points.
Further, your LOS should allow you to apply triggers to a specified relationship, initiating more favorable rate sheets and fee programs, while also assigning rankings to develop a dealer rating system that drives an action during automated underwriting. For example, if a specific dealer in your area has a history of sending borrowers with stronger on-time payment habits, your system might trigger lower credit score requirements for borrowers from that dealership.
Along the same lines, a built-in, cross-sell tool provides your institution an added advantage as your employees are immediately notified of potential preapproved borrowers identified through analysis of existing data and payment habits. By cross-selling to new or existing borrowers, your institution is able to further spread risk across multiple loans. Cross-selling tools are additionally enhanced when the LOS automatically updates approval as offers are accepted, calculating the borrower’s ongoing potential qualification as they accept new credit opportunities.
Being able to approve more loans by extending your standard lending parameters builds strong ties with dealers, which means potentially more loans for your credit union—a profitable and risk-reducing outcome. It can also open the door to more direct loans, giving you added customer wallet share and more opportunities to upsell insurance and other loan products.