don't have perfect credit…when we lend to our "real" members.

The bad side of lending at a credit union:

1. Too many of us are trying to take the easy way out. We're using third parties who are pitching snake oil. "New technology and scoring models allow us to revolutionize lending!" You'd think we'd be a little less gullible. Lending isn't easy, and lending to subprime borrowers is not for lazy lenders.

2. Precious few people in credit union land seem to understand the problems with risk layering–the practice of lending with multiple risks. Basically, a low FICO score is enough of a risk by itself. Add impaired ability to pay, a high LTV and extended terms, well, you have a mess.

We can all learn from the subprime mortgage market, the mother of all market meltdowns. Stated income programs–loans where the borrower does not have to prove their income–seem to have been designed for the lazy mortgage broker.

The subprime market is also suffering from risk layering. Making a mortgage to a 580 FICO borrower is tricky enough. Traditionally (prior to 2003), borrowers with this type of credit could only buy a house with 20-25% down. Or they could refinance an existing mortgage at 70% LTV. And you know what? Those borrowers typically performed pretty well because they had a big incentive to repay. However, when the market started making stated income loans at 100% LTV on large loan amounts for 580 FICO borrowers, it was just a matter of time before the meltdown.

So, what's my point? If you want to make subprime loans, you better be prepared to:

1. Work hard. Making subprime auto loans will require collecting paystubs, determining reasons for past slow credit, and even inspecting a lot of cars. You'd be surprised at how many high-mileage, poor condition, and previously wrecked cars are sitting at the back of the dealer's lot, waiting for the next subprime borrower.

2. Stick to your underwriting guidelines. You can't underwrite a 580 FICO borrower like a 720. Keep terms shorter. Require a better equity position in the car. Keep payments to an affordable level–regardless of how well the member appears to be able to pay on paper. Most subprime auto lenders suffer from severe peaks and valleys in their business because they chase business when the competition heats up, and they tighten up dramatically when the economy takes a downward turn.

3. Focus on your members. That means if you're trying to do subprime indirect, well, you better know your borrower. Do some research on credit scoring; members pay their credit union better than customers pay their bank. However, new members signed at the dealership probably won't pay like a loyal and established "real" member.

Consider a program to help your members with subprime credit refinance their existing 18%-30% APR auto loans. Refinanced loans are a lot harder to make than a new indirect loan, but you get the advantage of avoiding all of the borrowers who default very early in the loan. The longer they've paid their existing loan, the lower the risk you should encounter.

Bill Vogeney

Senior Vice President/Chief Lending Officer

Ent FCU

Colorado Springs, Colo.