Auto Finance Disruption: Putting Consumers In The Driver's Seat |
Posted: June 8, 2020 |
When you consider that the airline industry made it easy to compare options decades ago, it is shocking how antiquated the auto financing experience still is. Auto financing has somehow managed to evade many of the technological advances seen elsewhere.To get more auto finance news, you can visit shine news official website.
Auto manufacturing, purchasing and lending are key drivers of the U.S. economy. Last year, Americans bought more than 17 million vehicles. The scale of this market is largely made possible by auto loans. Over 85% of new cars were financed in 2019. It is shocking to find that such a valuable financial service is still marred by inefficiencies and a lack of consumer transparency that other industries have already overcome.
There are four key consumer problems with the industry: price dispersion, inconsistent risk-based pricing, high search costs and dealership markups. Problem 1: Price Dispersion Price dispersion is a fancy way of saying that consumers pay different prices for the same product. Most auto lenders claim to base rates and terms on the credit profiles of borrowers. In other words, all things being equal, a borrower with a higher credit score should qualify for a better rate. However, research indicates that auto loan pricing is much messier. According to a 2017 study of 2.4 million auto loans by 326 different financial institutions in 50 states, 54% of auto loan borrowers did not get the lowest interest available to them.
The researchers examined borrowers with the same loan term, car value, debt-to-income ratio, commuting zone and origination zone. They found the average borrower paid an interest rate that was 1.3 percentage points higher than the best rate available. In other words, most borrowers pay more than they need to just because they don’t know they have better offers available.
A related issue is that the FICO credit score brackets lenders use in their risk-based pricing models are inconsistent. Lenders often determine the rates of a borrower based on threshold FICO credit scores. For example, a borrower with a credit score above 600 may get a better rate than someone with a 595 FICO but no different than someone with a 690 FICO. However, another lender may have completely different threshold scores.
The study mentioned above found that on average, borrowers got a rate that was 1.46 percentage points lower than a similar lender that had a credit score just below the FICO threshold. The takeaway here is that shopping at multiple lenders is crucial if you want to get the best price available. It also means you can’t rely on the interest rate range lenders advertise. You need to check your rate before you know if a lender offers the best rate available.
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