ccording to USA Today, "The fastest growing market in auto financing is selling cars to people with bad credit." This industry--termed "subprime" financing--is worth an estimated $60 billion and is expected to grow approximately 15% a year for the next three years.

Some subprime lenders have made loans to applicants lacking enough income to repay. As a result, many of these consumers, especially low-income retirees, have faced home foreclosure and vehicle repossession. In fact, some subprime lenders have made too many loans to so many bad risk consumers that unpaid loans have forced these companies out of business. That's why many subprime lenders now are screening their applicants more closely and denying credit.

Your credit union, banks, and other financial institutions easily can access on-line databases for information about you and your credit history. They can find out whether you repay your loans on time, have had a repossession or foreclosure, or filed for bankruptcy. This information helps lenders tell if you're an overall good risk for a loan.

Subprime lending companies use these databases to focus primarily on financing homes or vehicles for individuals whose credit rating is too risky for traditional lending institutions. The typical subprime borrower has limited discretionary income, a less-than-perfect credit history, and cash flow concerns. These consumers also may be first-time purchasers with no credit history. In granting loans to consumers with risky credit ratings, these subprime lenders charge much higher interest rates, say 14% to 25% APR (annual percentage rate) for vehicle loans, depending on state usury laws.
   Credit unions look at
   five credit granting
   factors: character,
   capacity to repay,
   credit, current
   condition, and

In granting loans to
consumers with risky
credit, subprime
lenders charge
14% to 25% APR
for vehicle loans,
depending on
state usury laws.

Credit unions--a money-saving alternative
Subprime lending isn't standard practice for credit unions. Still, many credit unions offer an alternative to help members with credit problems. They make risk-based loans because they understand that members can experience circumstances adversely affecting their credit, such as loss of employment, extensive medical bills, divorce, death of the main breadwinner, failed business ventures, or bankruptcy.

Some credit unions require a co-signer or sufficient collateral, but might not increase the normal interest rate. For example, Educators Credit Union in Racine, Wis., grants loans to members with problem credit depending on individual circumstances. However, these loans require co-signers. Jim Henderson, senior vice president of member enhancement, explains that having co-signers helps offset risk-based lending risks. His credit union has a 90% or better loan-to-asset-ratio (meaning about 90% of members' savings is at work in loans to other members) and has very few problems with loans to members with blemished credit.

Railroad & Industrial Credit Union in Tampa, Fla., realized that many of its members with blemished credit were paying much higher rates to finance vehicles through subprime lenders or through "buy here, pay here" used-car lots. "We were turning down these members because of blemished credit," Kim Yarnelli, vice president of lending, explains. "We saw this as an injustice to our members and decided to do something about the situation. They have to have a car to drive to and from work and were paying high rates for this transportation."

Approximately two and a half years ago, Railroad & Industrial Credit Union decided to help credit-impaired members by making risk-based vehicle loans. To protect itself and its membership against possible loss, the credit union established risk-based loan pricing at a rate four percentage points higher than the normal rate. Financing through a dealership or a "buy here, pay here" car lot, these members would have paid a five percentage point to seven percentage point higher rate. Yarnelli is positive the credit union made the right decision.

"We have a $2 million portfolio of these risk-based loans. Our members are pleased and, to date, we've had only one repossession since we started the program." This credit union looks at five credit granting issues: character, capacity to repay, credit, current condition, and collateral.

"As a rule, there are three main events that can trigger a financial crisis: major illness, loss of job, and divorce," Yarnelli emphasizes. "If we can assist our members who are marginal, we do."

Contact your credit union
When you need to borrow money for whatever reason, contact the credit union first. Even if you know you have credit problems and believe you're not eligible for a credit union loan, contact the credit union to discuss your needs before signing an application elsewhere. You may be surprised at how your credit union can help you. Credit unions want to help members avoid the subprime lending institutions featuring high interest rates that can, in the long run, further damage credit, depending on an individual's ability to repay.

Dedication to helping members doesn't mean credit unions grant every loan request. They must remember their responsibility to all members and can't indiscriminately fulfill every loan application. Credit union lenders must treat every member fairly and equally according to fair lending practices--reviewing applications with care, researching each member's background and capability to repay a loan and, often, counseling the member about a better way to handle the specific financial need. If there's no way to help a member with credit problems, the credit union usually recommends a nonprofit consumer credit counseling service.

Credit unions don't like to deny member loan applications, but sometimes a denial is the only way to help a member evaluate problems and take responsibility for correcting a poor credit record. The people at the credit union understand that anyone can be late on a payment, experience an income shortage, or face an unexpected expense such as overwhelming medical bills.

Credit unions work closely with members who are struggling to make ends meet and trying to correct credit problems. Still, members who consistently pay their bills late, constantly overspend, and do little if anything to establish and maintain a good credit record cannot expect their credit unions to bail them out. These members usually resort to a subprime lender, where they also may be turned down because of new credit screening policies.

Protect your credit and use it wisely. Talk to the people at your credit union before you sign on the dotted line at a subprime lender. There's never a guarantee that you can borrow from your credit union or even the subprime lender, but your credit union will look at your credit history, the circumstances causing your credit problems, and do its best to help you re-establish good credit.

Meanwhile, do your best to avoid being trapped into a subprime lender's high-rate loan. The money you save is your own.

   Many subprime
   lenders are more
   closely screening
   their applicants
   and denying

©1998 Credit Union National Association, Inc.