Discontinued Car Models Speed Value Drops, Raising Lender Loss Risks

Discontinued car models decrease in value faster than current models, forcing lenders to adjust underwriting models to account for the increased loss risk, according to a UCLA Anderson Review study.

Lenders depend on predictable resale numbers, but the price drops when a model gets discontinued. Lenders also face higher losses after repossession. That’s because the car sells for less than the remaining balance on the loan.

This is important for subprime auto credit because many lower-income customers buy cheaper discontinued models. Lenders know that these cars carry more risk, according to the study’s findings. Lenders see a wider gap between the expected value and the auction result.

Subprime lenders will have to deal with smaller margins and greater losses. In addition, they will undergo more pressure to adjust underwriting. Rising losses force lenders to rethink pricing, down payment rules, and how they classify older cars.

A discontinued model can bring costly surprises. Higher losses can increase ABS servicing costs.

How Discontinued Models Hurt Loan Performance

Cars lose value once they leave the production line, which also means customers may have a hard time finding parts and service. These worries show up rapidly in resale numbers. The car becomes harder to move at auction. Prices fall below guidebook numbers, and lenders see losses they did not expect.

While sometimes cheaper to purchase, discontinued cars lose value more rapidly than current models, posing a bigger risk for lenders.

Losses increase when the auction cannot cover the unpaid balance. A lender may write a loan based on a stable resale value, but the value may drop after production for that model ends. That creates the shortfall.

A loan portfolio with many discontinued models will likely have a rough time. The higher loss hits all parts of the operation, affecting pricing, reserves, and performance forecasts.

This trend is more important in lower-income ZIP codes, where buyers cluster around cheaper used cars. Discontinued models show up more often in these regions. Lenders then will have to handle pockets of high exposure where the losses can pile up. Repossessions increase at the same time that resale prices fall.

How Lenders Respond

The high losses force lenders to adjust underwriting models fast. They may lower LTV caps, raise down payment rules, or shorten loan terms. All this to slow the rise of negative equity. Many lenders move discontinued models into manual review. They want underwriters to judge deals one at a time.

Some lenders may decrease exposure to discontinued models, while others may reprice loans to absorb the higher loss risk. Loan providers may watch regional resale curves. 

Discontinued lines of business can increase the demand for ABS pool credit protection. Investors demand stronger credit protection if trends for collateral are weaker. Servicers can put extra effort into managing the account before the repossession becomes finalized.

What This Means for Low-Income Buyers

Low-income buyers are most attracted to the car the dealer no longer sells because the price will be affordable. The research from UCLA identifies an underlying issue: The car won’t support the loan, and the lender could reject the application.

The lender could request an additional amount for the down payment and increase the interest rates. This impacts the individual who already had limited options.

In some cases, unable to qualify for credit, consumers turn to longer-payment loans, buy-here-pay-here lots, and higher-priced products. These options add to the payment hardship.

The payment burden increases the stress, which translates into the likelihood of default that, in turn, often means repossession. Repossession often creates an imbalance that brings tougher regulations.

Why This Risk Warrants Attention

Discontinued cars show the vulnerability of car loans. The car appears cheap, and the loan appears simple. But the trend of higher loan-to-value ratios on discontinued cars means lower-income borrowers must come to the loan table with more upfront cash than the average used-car buyer.

The subprime market needs improvement in its valuation practices to avoid harming those who are less fortunate, the borrowers.