Auto Financing Flex

Consumers are increasingly looking for greater flexibility in financing their vehicles. As an example, some like residual financing, such as the balloon lending program credit unions can offer as an alternative to traditional leasing or loan programs through Auto Financial Group. This program reduces consumers’ monthly payments by letting them pay off just a part of the principal during the term of the financing. When all the payments are made, the borrower pays the lender a lump sum or “balloon payment” for the difference.

According to Experian Automotive, all types of leasing, including residual-based financing, have grown from 24 percent to 31 percent over the last five years.

This is not surprising when you consider that Experian Automotive also finds the average auto loan amount has increased 16 percent since 2011. In 2011 the average was $25,873, while today the average loan amount has increased to $30,032. Some consumers are unable or unwilling to purchase a new vehicle and are looking to financial institutions for financing options.

In all of this, used cars, including certified pre-owned vehicles, have become an attractive option for consumers looking to lower their monthly payments and shorten their terms. According to a recent survey by Swapalease.com, an online car lease marketplace, 78 percent of drivers said they would consider using lease options, including residual-based financing, for their purchase of a used car or truck.

The Swapalease.com survey also found that most drivers polled thought more flexibility is needed overall in residual-based financing. More than half (54 percent) of consumers said they’d be interested in extending their term six to 12 months at the end of the original term. Almost three quarters—72 percent—said they’d consider refinancing into a residual-based loan after 36 months in a conventional loan. And 37 percent said they’d like to work with a dealer that could help them get out of their residual-based loan without penalty, if it meant they could use residual-based financing for a different vehicle.

To meet this demand, some companies are turning to options like balloon financing in place of traditional leases. The results for consumers are lower payments, flexible terms, the ability to have the title of the vehicle in the consumer’s name and access to several end-of-term options.

The underwriting process for these loans is the same as conventional loans, making the risk profile consistent under a particular credit union’s loan policy. If the borrower doesn’t make the final balloon payment at the end of the term to exercise his option to buy the car, he or she turns in the vehicle and walks away. If the market value of the car is lower than the balloon payment, the borrower is not responsible for the deficiency. If the value of the car is greater than the balloon payment, the borrower forfeits the difference.

Financial institutions benefit from higher yields with residual-based financing. In recent years, these yields have ranged from 1.5 percent to 3 percent more than with traditional financing, according to our analysis of client data.

According to a report by Callahan & Associates, credit unions achieved 10.9 percent growth in the number of loans processed during the first quarter of 2016; 82 percent of which were auto loans and first mortgages. We’ve seen several situations in which offering residual-based financing helped a credit union capture some of this growth in auto lending. Perhaps it is time other credit unions look into alternative options, as well.

Tim Kelly is president of Auto Financial Group, Houston.