In the fast-paced world of auto finance, staying ahead of the curve is essential. The industry is constantly evolving due to political changes, economic fluctuations, and shifting consumer behaviors, which directly affect interest rates, vehicle prices, consumer demand and affordability. These global uncertainties not only influence the cost of funds but also alter consumer preferences for certain vehicles, the availability of models, and ultimately, how lenders approach vehicle financing.
In this blog post, we explore the complexities of maintaining healthy margins in auto finance amid a highly volatile economic and geopolitical landscape. This quick read aims to provide insights and strategies for auto finance pricing and risk teams at banks and captives.
Shifting Market Dynamics
Tariffs and EV adoption are key factors creating uncertainty in the auto finance market, alongside record-high consumer debt and the ongoing impact of reduced new car sales from the COVID pandemic. The emergence of 96-month loan terms and fluctuating global interest rates add further complexity and risk to the auto lending landscape.
Let’s take a closer look at where we are:
Tariffs: Tariffs are having a paralyzing impact on the auto industry, affecting OEMs, dealers, and consumers alike. Tariffs, along with tighter vehicle supply, have led to increased new vehicles prices and decreased incentives, making financing a less appealing option for consumers. New auto loan rates remain elevated, hovering just 36 basis points (BPs) below the 25-year high recorded in June 2024, reported by CBT News*. According to Cox Automotive , the auto market is likely headed for a volatile summer season in 2025. When rates and prices increase, sales are expected to dip. However, slower sales could lead to renewed incentives and price reductions, potentially boosting consumer demand.
Electric Vehicle Adoption: The adoption of EV’s is growing, but there are many unknowns regarding market penetration and residual values. This uncertainty can impact the auto finance market, particularly in terms of how lenders price and manage risk for EV loans.
Record –High Consumer Debt: High levels of consumer debt are raising concerns. Balancing the risk of lending to heavily indebted customers with the need to maintain loan volume and profitability is a critical challenge. The emergence of 96-month loan terms is concerning, as well as the overall growth in the 85+ months segment, according to Experian’s State of the Automotive Finance Market Q3 2024 report**. Nearly 70% of used vehicle loans now have terms of 72 months or longer with scores increasing across all terms.
Reduced Volume of Certified Preowned Vehicles: The impact of the pandemic has led to changes in the used auto market and its values. This volatility affects vehicle affordability and can influence pricing and credit risk decisions in this segment.
Interest Rate Volatility and Consumer Behavior: The volatility in the interest rate environment and consumer behavior is affecting vehicle affordability. Lenders must be able to respond quickly to these changes to maintain profitability.
Rising Delinquencies: Delinquencies are on the rise, adding another layer of risk to the auto finance market. 30-day delinquent balances are up 22bps; 60-day are up 6bps, according to Experian**. Lenders need to be proactive in managing this risk to avoid significant losses.
All of this is adding to margin compression in the auto lending market, presenting a significant challenge and impacting lenders’ ability to maintain the desired level of profitability.
How To Respond to the Uncertainty in Auto Finance?
We believe that lenders can transform market uncertainty into growth opportunities by leveraging advanced analytics to understand customer price sensitivity, dealer behavior, and market conditions.
When interest rates are stable, lenders can afford to adjust prices less frequently, such as monthly, because the stable rate environment provides them time to react to market changes, like interest rates or competitor actions. But what we're seeing now is an environment where things are moving much quicker. There's more volatility across the interest rate environment, consumer behavior, and vehicle affordability.
We are also witnessing an increasing number of lenders investing in technological solutions to enable them to respond to market changes at lightning speeds. If you are not able to be as agile in your pricing strategy, you are poised to lose, whether in volume, margin, or both. As a matter of fact, I have spoken to several U.S.-based lenders that have recently realized that their pricing capabilities that were good enough 3 years ago have very quickly become a stumbling block in today’s environment.
So, let’s understand what advanced pricing analytics brings to the table in terms of operational and strategic advantage for your auto finance practice.
Maintaining (and Growing) Profitability in the Face of Margin Compression
To better serve customers and maintain profitability in the face of margin compression, lenders should adopt a data-driven approach. Here are the two critical areas that can be addressed with an AI-driven pricing analytics solution:
Unlock Advanced Pricing Analytics. If you already have an analytical framework, but it’s collecting dust, put it into action. The benefits will be quickly evident across the organization. Here are some of the more important pieces to achieve ROI:
Customer Price Sensitivity: Understand how a super prime customer looking at a 48-month loan is going to react to a change in price versus somebody in the near prime space who's shopping for an 84-month zero-down product. By understanding and forecasting the differences in customer responses to loan terms, you can get a much better idea of how you should be adjusting your prices across different segments.
Dealer Behavior and Commission: Understanding what happens after the interest rate leaves the lender and before the customer signs the loan agreement is critical. This insight helps lenders determine whether the customer will proceed with the loan and how profitable the loan will be once any markups, dial-downs, or dealer reserves are factored in. Forecasting the outcome with an AI-based pricing analytics solution, as well as influencing it based on historical dealer behavior, is crucial to reducing a lender’s uncertainty in this realm.
Reacting to Market Conditions: Whether it’s a change in the cost of funds or an aggressive move by a competitor, advanced analytics can help you to immediately understand the impact and respond by adjusting your pricing strategy. An integrated analytical framework will allow you to forecast not just how this customer is going to respond to a change in price or how this competitor’s behavior is going to affect your market position, but you can combine that into a portfolio-level view and see the impact on your forecasts in the coming week, month or quarter.
Future-Proof Your Decision-Making. No matter the change, these strategies will keep you prepared for what’s in store:
Forecasting and Scenario Simulation: Pricing and credit risk teams should leverage advanced analytics to forecast market changes, simulate pricing strategies, and test these strategies in the market. This can help in making informed decisions and staying ahead of the competition. You may even be able to take advantage of the volatile market, for example, by looking at new segments for EVs or offering loans on older used vehicles – all while maintaining the margin levels you need.
Price Optimization: Price optimization can help you answer questions like “what's going to happen if I raise prices in my super prime space by 5 bps and in near prime by 15 bps?” Or, “what's going to happen to my profitability if Treasury increases the cost of funds by 25 bps?” Some lenders go a step further and ask the pricing optimization platform, “given a series of simulations, what is the pricing strategy that optimizes for my KPI or a set of KPIs?” Running these changes through a suite of forecasting models to understand the impact on your lending operation is a critical first step to taking action.
Understanding Your Options: Taking price optimization capabilities to the next level is not only about helping lenders understand the implications of market change but also the possibilities for a response. For example, a lender is willing to let all of their prices move up or down by 50 bps. But they want their total booked volume or total conversion rate to be constant and maximize their net interest margin. What would their pricing strategy need to be within those 50 bps? A pricing optimization platform enables a lender to identify the point on the efficient frontier curve where profitability is maximized while maintaining a constant loan volume. Conversely, it also allows a lender to hold profitability constant and maximize loan volume, as well as explore all the possibilities in between.
Granular Pricing: In the auto lending space, pricing decisions usually aren't made for an individual consumer, but rather across groups of customers. Pricing optimization software allows us to identify price sensitive customers who would respond favorably to a small discount. Likewise, lenders are able to determine less price sensitive customers on that grid without seeing much change in demand. By doing that at the individual level, we're able to extrapolate up to an efficient frontier to help our customers visualize this universe of trade-offs between volume and profit. The biggest advantage of this capability is understanding the trade-offs: if a key competitor is cutting their rates, does this really make sense for me to do as well?
Perform Changes Live in the Market: Confidence in the final outcome is crucial when implementing a new pricing strategy. Live market testing is highly beneficial. This can involve selecting 10% of customers to receive test prices, or testing in a specific dealer network, geographic location, or segment of the credit spectrum. The ability to not only forecast outcomes but also to run Champion/Challenger tests to verify and validate these forecasts is a vital part of the process.
The Earnix Effect
I have a decade of experience managing global pricing analytics implementations for Earnix. What I've learned over this time is that an advanced analytics platform can deliver significant value quickly if you ask the right questions. That's why we always recommend that our customers start by observing the current situation, identifying small areas for immediate improvement to boost margin or volume, simulating changes, and running Champion/Challenger tests. Only after these steps should you develop a long-term strategy for your pricing structure.
A great example is an auto finance customer that approached Earnix for help with increasing pricing segmentation across different credit score groups to boost their acceptance rates and margins. Upon analyzing their booking probabilities, we found that customers with credit scores between 740 and 800 were being treated the same as those with scores between 700 and 740. The booking probability showed a significant difference between a customer with a 699 credit score and one with a 701. While the customer with 699 was thrilled to receive a better rate by just barely qualifying for a higher pricing bracket, the customer with 701 felt the opposite, as they were not seeing the benefits they expected.
Our recommendation to the auto lender was to implement a more granular pricing structure that closely aligns with credit risk. This adjustment led to a substantial increase in originations over a short period of time.
Get Confidence Before Deploying Changes in Pricing Strategies
Pricing analytics platforms powered by data science provide you with the confidence to execute pricing strategies effectively, enabling you to test approaches, set prices and anticipate competitor actions and market shifts. In the world of squeezed margins, this means higher agility and improved profitability across your auto lending portfolio. After all, you may discover that a 96-month term for someone with a credit score of 800 is not such a terrible idea, and it’s backed by data science.
I encourage you to get in touch with Earnix to learn more about our pricing optimization platform and how we can help you boost your margins.
* CBT News, Fed holds rates steady as auto market braces for volatility, May 2025
** Experian in their State of the Automotive Finance Market Q3 2024