“We need to increase rates 50 basis points in all cells in order to meet our spread target for the next release.”
This request is quite common among auto finance vendors. Yet, it is also more challenging to fulfill than you might think. Most auto finance companies are not able deploy rates fast enough and without IT’s help. Moreover, many let the cost of funds and product type alone dictate the rates they would offer, leaving other data variables out of the equation. Such strategies may affect loan volume if priced too high or threaten profitability and increase delinquencies if priced too low.
It may be especially challenging in an unpredictable rate environment accompanied by high vehicle prices.
For example, according to Cox Automotive March 2023 Report, the U.S. new vehicle market is being reshaped by higher prices and many automakers that traditionally served buyers with lower credit scores struggled with sales in Q1, as rates and credit availability remained an obstacle for many buyers. In the UK however, car finance new business fell by 8% in March 2023 compared to the same period in 2022 and used car business fell by 10%, as reported by the Finance & Leasing Association*, driving competition among lenders for remaining business.
Such a climate may give some auto loan lenders a reason to pause – to the point of rethinking their past aggressive strategies – to avoid pricing loans incorrectly and affecting their loan profitability in the long run.
Going back to the initial request to increase rates by 50 basis points…
This initial question usually leads to two more. “How do we know that 50 basis points (bps) is the right amount? What will this do to my pull through and overall volume?” Inevitably the answer to both was “wait and see.” “Be prepared to be reactive. We will see in next month’s auto loan volume numbers how this change impacts the overall product.”
This approach always leaves a lot of frustration within pricing teams. While it is important to keep your spread target and cost of funds in mind when pricing and deploying auto loan rates, it is just as important (if not more) to understand how customers and the overall market would react to pricing adjustments.