Drive Your Way to Better Credit

If you keep running into roadblocks in your attempts to rebuild your credit, the answer may be at hand, but it is going to cost you.

Over the last few years, the economy has laid waste to millions of credit reports.  If you lost a job and fell behind on your bills, you know what I am talking about. Maybe you leaned on your home equity line of credit more than you should have and when you home lost value; the bank froze your credit line.  Without a backup plan to ease you through the rough spots, your credit profile became a house of cards, and began its slow motion collapse

After struggling for a couple of years, you worked through your financial, work, and housing issues but your credit….it is a mess.  Your once pristine 750-credit score profile is in shambles.  You still have some good credit, but it is old.  Your credit score ,let us not go there.

You cannot get a home loan to buy a house.  Even if you have a 750 credit bureau score, you will not be able to secure the unbelievably low mortgage rates that are currently below 4%, if you owe more on your home than it is worth.  How much harder is it for you if you are trying reestablish good credit in a market where conservative loan underwriting is the new normal?

What is a good person with some past credit problems suppose to do?  The answer to this question may surprise you.  Go buy a car.

General Motors, Ford, Chrysler, European and Korean manufactures were all profitable by the first quarter of 2011, following the industry collapsed in 2008 – 09.  In 2009, if your credit score was under 680, you could not finance a car without a large down payment.  Today that has changed.

My contacts in the auto finance industry all say that getting credit to finance a vehicle is almost back to the pre-recession frenzy.  The main difference is the banks are not
extending credit and terms on higher mile vehicle as they did before, smart move.  The other change is more borrowers are required to verify income than in the past.

You can thank the expiration of the cash for clunker program in 2010, for the return of liberal lending standards.  Auto sales dropped and the industry was looking for a solution to increase revenue.  One option was to raise prices at the expense of sales.  The alternative was to expand your customer base by lending to the millions of buyers who were shut out of the market when the loan underwriting criteria tightened up.  The auto industry and the lenders supporting the industry elected to loosen up and sell more cars.

If your credit is rough but you have a good job and income, the auto industry is looking for you.  If your credit is, all bad you still might not get credit but walk in with 30 to 50 percent down and a company like Santander might take a chance.  Ally Finance and Capital One are making loans on rough credit but there are others.  If you tried two years ago and the auto authorities said no, now is the time to try again.

You need to have a stable job and an ability to pay.  If your credit is bad, and your income and job are not verifiable, your chances of financing a car are slim to none.  No income verification loans are a thing of the past for sub-prime auto buyers.  Avoid
older model, higher mile vehicles as most lenders have set age and mile limits
for the vehicle they finance.  Do you have a recent bankruptcy?  You in luck, you have a decent chance of getting financed as long as you have stable income and can afford a payment.

Individuals with credit scores of 620 and lower in many cases will get financing.  Past negative credit such as a bankruptcy and home foreclosure in many cases will not eliminate your chance of securing auto financing as long as your job is stable and your income is sufficient.    If you have multiple vehicle repossessions in the past couple years, do not get you hopes up too high.  Some lenders will qualify non-prime borrowers for a monthly auto payment that is equal to 20 percent of their gross income.  You might be able to get by without a down payment.

Show up at the car dealer with a pay stub and work number and the dealer will do the
rest.  Buying a vehicle is not cheap, but some auto finance companies have loosened their lending standards allowing those with negative credit to get financing when mortgage and credit companies say no.  Yes, it is true; you can drive yourself to better credit.

Questionable Results, “Cash for Clunkers”, One Year Later

The one-year anniversary ending last years “Cash for Clunkers” auto stimulus plan was marked by the release of a research paper by Atif Mian University of California, Berkeley and NBER Amir Sufi University of Chicago Booth School of Business and NBER.  The paper entitled, The Effects of Fiscal Stimulus:  Evidence from the 2009 ‘Cash for Clunkers’ Program.

The paper evaluates the impact of the governments 2009 “Cash for Clunkers” program and sets out to determine if this fiscal stimulus program actually increased vehicle purchases or did it merely shift the purchase date of already committed auto buyers a few months forward. 

Atif Mian and Amir Sufi differ from most of the economists making public statements and publishing papers that garner the attention of the public.  Most economists are theorists.  A theorist relies on economic models that employ concepts that have built-in assumptions regarding the relationships between different variables.  The variables are viewed as relatively constant over time and therefore are seen as predictive. 

Mr. Mian and Sufi are practical or mathematical economists.  This field uses calculus, algebra and statistics among other mathematical disciplines to provide analysis that is based on the crunching of the numbers.  The mathematical modeling field is still in the minority but growing.  This type of analysis can be used as a predictive tool but is more useful for analyzing the impact of certain fiscal stimulus programs after the fact. 

Recapping the “Cash for Clunkers” program, the government gave car buyers between $3,500-4,500 to trade in their old gas-guzzlers for newer, more fuel economic vehicles.   The plan would help inject cash into the economy through vehicle purchases and remove higher polluting vehicles from the road. 

The program paid nearly 700,000 car buyers nearly $2.9 billion.  The program definitely increased car sales in July and August of 2009, well beyond what they would have been had the stimulus program not had been in effect.  The authors estimated the program boosted sales by 360,000 vehicles. Once again, the question is, did the stimulus motivate individuals to purchase vehicles, or did it merely move up the purchase date of people already planning to buy a vehicle? 

The only way to answer this question is if there is a control group within the experiment.  The control group is the one that has almost no clunkers on the road to trade in for the purchase of a new vehicle.  By comparing auto sales in parts of the country, that have many clunkers with those areas that have relatively few, the authors think they were able to gauge the impact the auto stimulus program.  The states of Nevada and Arizona had so few clunkers traded in, that by definition they could serve as the control group.  

Was the increase in auto sales borrowed from the near future or did the program result in auto purchases that would not have occurred until a couple of years down the road if the program had not been in effect.  The Council of Economic Advisors estimated that it would take 5 years until the programs effects would be reversed.  The National Highway Transpiration Safety Administration estimated the effects would be reversed in 3 years.  The author’s analysis found that almost all the increase in sales was pulled from the short-term.  The programs effect on auto sales was reversed after 7 months. 

“You could argue that if you’re in the depths of a recession, maybe shifting purchases of automobiles by even a couple of months, maybe that is a useful thing to do,” Sufi says.

“But,” he adds, “I think it’s incredibly important for policymakers to understand that whenever you induce the purchase of any good — whether it be homes, whether it be a washing machine — you are in some sense stealing those purchases from the very short-term future.”

The authors are neither for nor against the program but merely stated their findings without having pre-conceived ideas as to what the findings would reveal.

The study should be instructive to all lawmakers considering future stimulus programs.  Does the economy really benefit from fiscal stimulus and contribute towards growth or does it borrow from the near term to satisfy the now?  The answer to this question may lie in which camp of economic thought you find yourself in.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1670759

General Motors to Grow Business though Ally Financial

Ally Financial, formerly known as GMAC is adding head count.  In an industry as hard hit as banking and finance, any expansion is seen as a welcome sign.  According to a company employee, Ally is looking to add 100 Retail Underwriters for its auto business by year-end.

General Motors sold GMAC in 2006, becoming the only major auto manufacturer without a company owned financing arm.  In the fall of 2008 GMAC (Ally bank) became a bank holding company in order to survive the credit meltdown.   The legal shuffling enabled GMAC in participate in the US Treasury Troubled Asset Relief Plan (TARP).  GMAC has received over $16 billion in bailout funds from the US taxpayer.  In May 10^th of this year, GMAC changed its name to Ally Financial.

General Motors looking to grow its business needed to come up with a plan in a market that is projected to sell only 11.2 million new cars and light trucks in 2010.  Ally Financial is already purchasing nearly 90% of the new vehicle financing contracts from its GM dealers.  Banks like Wachovia Dealer Services, Wells Fargo Auto Services and Chase are buying the majority of the used vehicle contracts.

If Ally expands into the subprime market for used vehicles and exerts pricing pressure on the prime side of the business, GM can grow its business in a market where the average consumer is still nervous to make a large purchase.  GM dealers are tired of turning away willing buyers and Ally Financial, possibly in response to General Motors CEO Ed Whitacre considering additional outside financing partnerships or creating in-house financing is answering the call to provide more support to the dealer community.  Near zero interest rate loans from the Fed reduces the severity of the risk.

The move by Ally should provide a small spark to the struggling auto industry.  The other banks and auto finance companies will respond to Ally’s expansion by re-examining their own credit and pricing policies.  Each bank will have certain segments of its portfolio that are performing at or above expectation and these segments will be looked at when banks consider loosening underwriting standards.  Underperforming portfolio segments may be re-evaluated and adjusted to find a niche where price reduction will result in additional loan volume and profitability.  The object of this delicate game of chess is to avoid losing market share. 

So, who are the winners and losers?  Some consumers will get lower interest rates.  Other borrowers who were deemed too risky in this market will now be able to secure vehicle financing.

In the short-term, Ally Financial and its competitors should benefit if they are able to manufacture demand in the market through a loosening of lending policy.  Ancillary business such as warranty providers will also benefit from the increased business. 

The banks and finance companies will have to wait 12 – 18 months to determine the success of their expansion.  If the banks made smart loans, profitability will rise.  On the flip side if the banks took too much risk, losses will rise again, hurting profitability and threatening whatever gains the market achieved.

High Negative Equity Supresses Auto Sales

The media has trumpeted  loud and often the real estate market is in trouble.  Home values have dropped nationwide leaving 23 percent of the homes underwater. (1)

Lesser mentioned is the number of vehicles underwater or upside-down to borrow a term used in the auto industry.  Being upside down simply means you owe more on the vehicle than it’s worth. 

 The auto industry does not have available statistics on the extent of upside-down auto loans but the numbers may be greater than the number of homes that are underwater.

How did this happen?  What impact does the prevalence of upside-down auto loans have on the number of vehicles sold today?

Twenty or so years ago a car buyer needed at least 10 percent of the purchase price of the auto as a down payment before the dealer would put the customer on the street.   If your credit was less than perfect, you were looking at a cash down payment of 20 to 30% of the purchase price.

In the 1990’s credit loosened up as more money was made available by the banks, finance companies and credit unions for financing vehicles.  The dealerships had more financing options to offer the buyers, creating an environment where a broader segment of society was able to finance a vehicle. 

After the World Trade Center Bombings, the prior guidelines governing auto financing began to disappear and an era  resembling the wild west of auto lending began to take its place.  In the 1980’s auto financing was limited to 36 or 48 months max for a new vehicle.  Five years ago 72 month financing terms was the norm to get the car buyer in the vehicle of their dreams at the lowest possible payment.  Terms of 84 months and in rare circumstances 96 months stretched financing terms  to the extreme all in the name of rolling another unit off the lot. 

Combine a loan term of 72 months with first year depreciation as much as 30 to 40 percent in some models, the borrower may not see positive equity in the vehicle until 60 payments have been made.

Zero down, Zero percent APR was the  incentive U.S. auto manufactures offered on some models to get buyers back in the dealership after 9-11.  The zero down enticement which at one time had been the exception had turned into the expectation for many buyers, putting pressure on the dealers and lenders alike, pushing the average loan to value to record heights.  The car buyer was calling the shots in many cases.

The paradigm in the auto industry had shifted but the habits of many buyers had not.  A new vehicle every two or three years is a fact of life for many drivers.  What had changed was zero down combined with extended financing terms and auto lenders adjusting loan policy to accomodate the escalating negative equity in an increasing number of trade ins.  As the economy tanked and unemployment rose, the increasing number of repossessions carried with them in a greater severity of loss.

Reality dealt a harsh blow to the auto industry in the fall of 2008 when vehicle values plummeted at the auctions just as the available credit for financing dried up.  The car buyers who had been accustomed to trading in their vehicle every two or three years was now sitting on the sideline as the auto lenders were now unwilling to absorb the negative equity some drivers had been rolling from one purchase to the next for the better part of a decade.

What impact does this have on auto sales?  The car buyers who had purchased their last two or three vehicle with little or no down payment are finding that they will have to postpone their next vehicle purchase until the loan on their current vehicle is paid off.

(1) credit.com article by John Conroy 8/13/09

Jeff Hubbell has been in the auto finance industry for the last 13 years.

Cash for Clunkers, The Rest of the Story

Last week I was amused by the headlines blaming, the “Cash for Clunkers” also known as  Cash Allowance Rebate System(CARS), for the miserable automobile sales in the month of September.

 The ubiquitous statement of the week in both print and electronic media was that offered by Reuters contributors Kevin Krolicki and David Bailey, U.S. auto sales tumbled by 23 percent in September as showrooms emptied after the government-funded boom from the “cash for clunkers” program, with General Motors Co and Chrysler hardest-hit.

 Edmunds.com reports “September’s light-vehicle sales rate will fall to 8.8 million units . . . the lowest rate in nearly 28 years, tying the worst demand on record.  After the cash-for-clunkers program boosted August sales to their first year-over-year increase since October 2007, demand has plunged. In at least the last 33 years, the U.S. seasonally adjusted annual rate has only dropped as low as 8.8 million units once — in December 1981 — with records stretching back to January 1976.”

The implication being that “Cash for Clunkers” was responsible for the huge increase in vehicle sales in August and the resulting crash in September.

 While CARS had a significant impact on August auto sales, it was hardly the only factor.  Talk to any car salesperson that has been in the business for over five years.  Talk to anyone involved on the production end of an auto finance company or bank and the rest of the story becomes clear.

 Every year with few exceptions, auto dealerships sell more passenger vehicles and light trucks in the month of August than in the month of September.  The well established pattern of auto sales in the months of August and September for the years 2006-09 is illustrated in the linked chart below.

  http://www.box.net/shared/2k2bef71d1

The reasons for the yearly drop off in September auto sales are a common topic of conversation within the industry, but are rarely discussed outside.

 The most obvious answer is August has more working days than September does by the simple fact August has 31 days in the month vs. September’s 30 days.

 Historically the auto manufacturers have delivered the new models to the dealerships after summer has concluded.  The auto buyer looking for the release of  next years model or wants to be the first one on the block with the latest model waits until the end of September or the beginning of October to make the purchase, helping to contribute towards the first three weeks in September being a slow time at the dealerships.

 Lastly, August is prime vacation time when families want to make the end of summer memorable with the purchase of a new vehicle.  As September rolls around the focus is on getting the kids settled in school, beginning the next project at work, or sampling the latest fall fashions at the department store, taking time and attention away from the auto market.

 Yes, “Cash for Clunkers” did affect September’s slow down in auto sales, by absorbing pent up demand and reducing the available inventory at the auto dealers, but the cyclical variations in the market played their part in the reduction of sales as they do every year.

 Blaming “Cash for Clunkers” as the sole reason for the slow down in auto sales is to ignore the market factors that auto sales professionals and their financing partners allocate as a regular part of business.

Jeff Hubbell worked for a major auto lender for 13 years.

Data in sales chart from Autoblog.com, Edmunds.com, Wardsauto.com