The suggestions are in "Steer Clear: How Credit Unions Help Car Buyers Avoid Predatory Lenders," a report authored by William Myers, a senior fellow with the Aspen Institute and former founder and CEO of the $54 million Alternatives Federal Credit Union, headquartered in Ithaca, N.Y.
Alternatives FCU has won awards and grants for its consistent record of working with lower-income members and communities.
Myers identified a niche in the auto loan market between the very competitive auto lending to consumers with the strongest credit scores and auto lending to consumers with so-called "D" and "E" paper. The report defined "D" paper loans as those to consumers with credit scores between 550-599 and "E" paper loans as those to consumers with credit scores below 550.
Myers asserted that credit unions should begin offering these sorts of loans for two reasons. First, they are good business and credit unions should not ignore a potentially profitable market. Second, making these sorts of loans is part of credit unions' mission.
"Federal credit unions and many state credit unions are chartered with a statutory mission to serve people of modest means," Myers wrote.
"All credit unions in the U.S. are member-owned, not-for-profit cooperatives established as part of a movement to provide consumers with more affordable alternatives to the for-profit banking industry and to put predatory loan sharks out of business."
Myers said credit unions may not offer these kinds of loans because of their uncertainty and unfamiliarity, downside loss potential, lack of data about this market, board apathy or reluctance and regulatory concerns.
To counter these concerns, Myers brought forward research conducted among 400 credit unions that had taken part in the foundation's real solutions program. Myers acknowledged that the credit unions chose to take part in the study and were, in that sense, self-selecting. But he also said the point of the study was to document the ideas and innovations that he said were widespread among credit unions.
"So often I have sat with a credit union CEO and he or she has reported results from this program or that," Myers said in an interview about the report. "No credit union is everything when it comes to these sorts of innovations, but a lot of credit unions are doing small parts, and we wanted to tap into that."
The report began by seeking to dispel the myth that making these sorts of loans always cost more in losses than they are worth.
The Steer Clear report pointed out that while it is true that loans to borrowers with low credit scores carried additional risk of loss, credit unions could price the loans to reflect that risk, make money and still offer consumers a better loan than they would get from a predatory competitor.
Myers discussed the experience of the now $894 million University Federal Credit Union in Austin Texas. Even though the CU's experience with this sort of lending predated the study, Myers said that University FCU had made valuable inroads into dispelling the myth that these sorts of loans are automatically money losers.
The study indicated that University had charged 17.00% on its car loans to members with the lowest credit scores versus 6.00% on its car loans to members with the best credit scores. This gave University a spread of 7.92% on the 17.00% loans versus a spread of only 2.68% on the better score loans, even with loan losses of almost 5% on the higher interest lending versus only 0.03% on the better paper, the report said.
The report observed that at even a 17% interest and other more favorable terms, the CU was still the much lower cost option for these lower credit score consumers who faced interest rates of 25% or more from other auto lenders in their area.
Myers pointed out that credit unions were not the lowest cost option because of the interest rate but because of their role in the entire auto purchase. Because buyers with low credit scores have limited options, they often face a more limited market from which to choose a car. This can mean that not only are lower credit score borrowers without a credit union option paying a good deal higher interest rate for any auto loan they do get, they are also usually paying a good deal more for the car than they would otherwise have to.
"As bad as an interest rate of 27% or 30% or 300% might be, that's nothing compared to buying a $2,000 car and having to finance it to the tune of $8,000," Myers said. "Even at rate of 17%, credit unions can have a dramatic effect on borrowers who have no alternative to the extremely bad deal offered by others dealers and lenders."
Another key point the report makes is that credit unions should not believe they would have to offer these loans perfectly right away.
"Nobody gets a new market right on the first try," the report said. "You must allow time to track outcomes and to revise policies and procedures. But make program changes through policy, not through drift. Once you have a policy in place, follow it or revise it."
Myers made the case that the taking on a new markets like these often means credit unions must grow in unexpected ways. "I have had CEO say things like 'adding these loans meant that I had to grow my collections staff when I didn't really want to,'" Myers said, "but sometimes that's what growth means, going in unexpected directions. If adding a loan product which is profitable and wanted by your members means that you need to add resources to support that product, add the resources."