Bad credit is looking good to auto lenders

This post comes from Marilyn Lewis at MSN Money.

Who knew that defaulting on your mortgage would make you attractive to lenders? These days, The Wall Street Journal reports, mortgage trouble may mark you as a good prospect, at least for an auto loan.

The article, "Auto lenders speeding past mortgage woes," says:

Auto lenders are pursuing an unlikely growth market: people who have fallen behind on their mortgages.

In the first three quarters of 2011, auto lenders issued roughly 205,000 loans to borrowers whose credit records showed they have been at least 60 days past due on their mortgage or experienced a foreclosure, up from roughly 80,000 during the same period in 2006, according to credit bureau Experian PLC.

Credit card issuers, too, are looking twice at people who once may have been rejected as credit risks. In the last four years, 36% more credit cards were issued to borrowers who'd been through foreclosure or had been 60 days or more behind on mortgage payments, says the Journal.

Growth in "deep subprime"

The number of subprime auto loans grew in the third quarter of last year, says credit-rating company Experian in its December report:

According to its quarterly automotive credit analysis, 21.87% of all new vehicle loans went to customers in the nonprime, subprime and deep subprime categories. The largest percentage increases were in the two highest-risk segments -- deep subprime, which jumped 17.3%, and subprime, which jumped 17.8%. Nonprime loan share jumped by 12.5%.

The analysis also showed that the average consumer credit score for both new and used vehicle loans dropped in Q3 2011. For new vehicle loans, the average credit score fell from 769 in Q3 2010 to 763 in Q3 2011. For used vehicle loans, the average fell from 683 in Q3 2010 to 676 in Q3 2011.

"Nearly half of all consumers fall into non-prime, subprime and deep subprime risk categories," Experian's Melinda Zabritski said in an autumn 2011 report on auto lending (requires sign-up). Post continues below.

What the heck is "deep subprime"? We wondered, too. Chatting by phone, Experian spokeswoman Roslyn Whitehurst explained. In the reports on auto lending, Experian used its Scorex PLUS proprietary credit scoring system:

• Superprime, 740 and above.
• Prime, 680-739.
• Non-prime, 620-679.
• Subprime, 550-619.
• Deep subprime, below 550.

Although the percentage growth in deep subprime loans looks huge, it's a small proportion of all auto loans. At the end of the second quarter last year, just 2% of auto loans were to deep subprime customers, according to Experian's fall report.

Changing ideas about risk

"Are lenders nuts?" you might be wondering. Not hardly. They have a number of reasons for embracing the subprime category.

For one, they're seeing fewer bad auto loans. With bad loans from 2007 and 2008 mostly behind them, repossession rates are falling, too -- "from 0.67% in Q3 2010 to 0.62% in Q3 2011," according to Experian.

Also, the recession has stood conventional lending wisdom on its head as consumers keep up their credit card payments while defaulting on their mortgages.

That's apparently true, too, with auto loans. The Journal writes: "Whereas mortgage payments used to be sacrosanct for most borrowers, credit experts say, falling home prices and rising unemployment during the recession led more people to pay their car loans and not their mortgages."

And lenders, after all, need customers. "Providing loans to these risk tiers opens the market to significantly more prospects," Experian's Zabritski says in that autumn report.

And then there's the profit. Subprime is apparently tantalizing because, if the risk is managed well, the higher interest rates charged to borrowers with lower credit scores can be huge.

Good for the industry

For example, the Journal tells the story of Roberto Suarez, who's "behind on the mortgage on an investment property in Sanford, Fla., after a temporary bout of unemployment."

After his car was wrecked, Suarez bought a new one:

Mr. Sanchez received a 60-month loan with a 15.99% rate. A borrower with top-tier credit would have received a rate of about 5.99% on a similar loan, Mr. Hurley (Sanchez's auto dealer) says.

An auto lender summed up his company's rationale to the Journal:

Steven Bowman, chief credit and risk officer of General Motors Financial, says the company now gives less weight to mortgage delinquencies and will consider offsetting factors, including a good score on the company's proprietary measure of credit-worthiness.

"Before the last recession," he says, "a mortgage delinquency was considered an early warning sign that bad things would happen." Now, he says, "we think there are some opportunities for good, profitable growth."

All this lending helps the whole auto industry, says Experian: "This was good news for automotive manufacturers, as nearly half of all consumers fall into non-prime, subprime and deep subprime risk categories."

Car sales rose 10% last year -- up 9% in December alone, Automotive News reported today. A recent survey of independent analysts forecasts another 6% to 7% rise in auto sales this year.

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