Indirect auto lending, where a credit union partners with car dealerships or a direct lending CUSO to offer financing to their customers, has become a popular method of expanding loan portfolios and attracting new members. However, like any financial service, there are both benefits and drawbacks associated with this approach. This article will explore the pros, cons, and considerations of credit unions offering indirect auto lending to help decision-makers weigh the potential risks and rewards.

Here are the pros of indirect lending:

Increased Loan Portfolio and Revenue: One of the most significant advantages of offering indirect auto lending is the potential for increased loan volume. By collaborating with various dealerships or a credit union service organization (CUSO), credit unions can reach a broader audience and provide financing options to a larger pool of prospective borrowers. This can lead to a steady flow of new loans, generating additional revenue for the credit union.

Convenience and Flexibility: Indirect auto lending allows members to obtain financing directly at the dealership or through third-party lending CUSO. An indirect program allows the member to “one-stop-shop” at the dealership and not be required to make buying a car a two-step process – get qualified at the credit union, then negotiate the deal with the dealer.

Expanded Membership Base: Indirect auto lending can be a powerful tool for attracting new members to the credit union. As car buyers seek financing options at partnering dealerships, they may be drawn to the competitive rates the credit union offers. This increased visibility can help credit unions expand their membership base and strengthen their presence in the community.

Diversification of Loan Portfolio: Credit unions can diversify their risk exposure by including indirect auto loans. This is especially valuable during economic downturns when specific sectors may be more vulnerable. Auto loans typically perform well in various economic climates, providing a stable source of income for the credit union.

Streamlined Application Process: The partnership with dealerships or CUSOs often facilitates a more streamlined loan application process for borrowers. Car buyers can apply for credit union financing directly at the dealership, which can significantly reduce paperwork and increase convenience. This ease of application can improve the overall customer experience and enhance the credit union’s reputation.

Here are the cons of Indirect Auto Lending:

Potential Conflicts of Interest: Credit unions must ensure that their partnerships with dealerships and indirect lending partners do not lead to potential conflicts of interest that may negatively impact member interests. A credit union can never lose sight of the dealership’s number one priority is selling cars. Sometimes, this drive for car sales results in the salesperson or sales manager hedging some of the input on the borrower’s application to help that car buyer qualify for the loan.

Loss of Direct Member Interaction: Indirect auto lending involves third parties, which can result in the loss of direct member interaction during the loan origination process. This may lead to reduced opportunities for personalized service and member engagement. Also, the credit union is not always seen as a banking option but only as a funding option for auto purchases. The chance to build brand loyalty or recognition in the car purchase interaction is eliminated.

Risk Management Challenges: Indirect auto lending introduces additional risks to the credit union, especially if proper risk management practices are not in place. Delinquencies or defaults on indirect loans can impact the credit union’s financial health and may affect member service if resources are diverted to address these issues.

Potential Credit Quality Risks: Indirect auto lending can introduce credit quality risks to the credit union’s loan portfolio. Since the credit union does not directly interact with borrowers during the loan origination process, there may be a lack of insight into the borrower’s financial situation and creditworthiness. This increases the chance of approving loans for individuals with higher default risks.

Competition and Rate Compression: Credit unions may face stiff competition from other financial institutions to gain business from partnering dealerships. This competitive environment can lead to rate compression, where credit unions may offer lower interest rates to match their rivals, potentially impacting profitability. On more than one occasion, I’ve seen a credit union eroding its profitability because of dealer incentives and CUSO fees.

Dealer Compensation and Relations: Some dealerships receive compensation from lenders for driving loan business their way. While this can be an effective incentive for generating loan leads, it can also result in a conflict of interest. Credit unions must carefully manage these relationships to ensure they do not compromise their members’ best interests.

Administrative Burden: Handling indirect auto lending can add an administrative burden to the credit union’s operations. Dealing with multiple dealerships, loan applications, and processing paperwork necessitates efficient management systems to avoid potential bottlenecks and delays. Any indirect program must have a very efficient loan underwriting and processing system.

Complexity and Communication: The indirect auto lending process can be complex, involving multiple parties and documents. Ensuring clear communication and transparency with members is essential to avoid misunderstandings or dissatisfaction.

Finding the balance between dealer and member loyalty.

1. Clear Communication and Expectations: The credit union should establish clear communication with its lending partners (dealerships) and set expectations regarding the level of service and support expected for credit union members. This includes guiding fair lending practices, member-centric service, and transparent disclosure requirements.
2. Member-Centric Approach: Despite the involvement of dealerships, the credit union must remain member-centric in its decision-making. The interests and financial well-being of the members should always come first, and the lending program should be designed to benefit them.
3. Competitive Rates and Terms: The credit union should negotiate competitive rates and favorable loan terms with its lending partners. This ensures that credit union members get access to the best possible financing options while also fostering loyalty among members.
4. Regular Performance Evaluation: The credit union should regularly evaluate the performance of its indirect lending program and dealerships to ensure it aligns with the credit union’s overall mission and goals. This evaluation should include feedback from both dealerships and credit union members.
5. Member Education and Support: Providing educational resources and support to members throughout the lending process can help them make informed decisions. Understanding their options and responsibilities makes members more likely to feel satisfied with the credit union’s services.
6. Ethical Dealer Relationships: When collaborating with dealerships and indirect lending partners, credit unions should choose reputable and trustworthy partners. Ensuring these partners share the same commitment to customer service and ethical lending practices is vital. Dealerships that prioritize member satisfaction and comply with fair lending practices will contribute to a positive member experience. This dealer choice is not a one-and-done situation but needs to be continually monitored, especially when sales leadership at the dealership changes.
7. Efficient Loan Approval Process: An indirect lending program requires quick and efficient approvals. Credit unions must streamline loan approval processes to reduce wait times and provide a positive borrowing experience.
8. Risk Management: While offering indirect auto loans can expand the credit union’s lending portfolio, it also introduces additional risks. Credit unions should implement robust risk management practices, including evaluating creditworthiness and setting appropriate lending limits.
9. Personalized Service: Credit unions have a unique advantage in offering personalized service to their members. This should extend to the indirect lending program, ensuring members feel valued and supported throughout the loan application and approval process. You can delegate the lending process to the dealership or CUSO, but you can’t abdicate your responsibility for fair and ethical lending practices to the dealership or the credit union.
10. Transparent Incentive Structures: If the credit union has incentive structures for dealerships, these should be transparent and fair. Incentives should not compromise the members’ best interests or lead to practices that may harm members.
11. Member Feedback and Engagement: Regularly seeking feedback from credit union members about their experiences with the lending program will help identify areas for improvement and gauge overall member satisfaction. Engaging with members through surveys or focus groups can be beneficial. Reviewing this feedback with the dealer or CUSO should be regularly scheduled so any corrective action can be implemented. Constant refinement ensures the program remains relevant and effective for dealerships, the CUSO, and members.

Indirect auto lending can be a viable strategy for credit unions to expand their loan portfolio, attract new members, and diversify risk. Historically, the churn rate of indirect loans is higher than direct loans, so sometimes, an indirect program makes churn management much more difficult. Credit unions must strike the right balance between member service and responsible lending practices to minimize potential negative impacts and maximize positive ones. This involves choosing reputable partners, providing adequate member education, offering competitive rates, and maintaining open communication channels with members throughout the lending process. By doing so, credit unions can use indirect auto lending to enhance member service and effectively meet their members’ diverse financial needs.