General Motors (GM) just divested itself from GMAC, now Ally Financial, its captive-financing arm. In doing so, the company sold Ally shares totaling $1 billion and made a profit of $300 million. This sends a message that GM is fully committed to its financing unit, GM Financial, formerly called Americredit.
The first task on the list for this division is to offer subprime car loans.
In other industries, subprime lending is considered taboo at this time. Lenders are steering clear of borrowers whose FICO scores are below 680. In the auto sector, this is not the case because consumers need cars but the credit rating of many has taken a beaten in recent years.
Subprime lending within the car industry is alive and kicking.
The practice of subprime lending for automobiles is different from that for homes. In both situations, borrowers provide down payments. However, the down payment to income ratio is usually substantial for a home mortgage, while it is much less for a car loan.
In addition, a portion of an auto loan down payment can be offset by trading in another vehicle.
Compared to a mortgage payment, a monthly payment for a car loan is rather small. Lenders are finding the interest rate spreads very favorable, as it costs them little to nothing to access capital. When GM acquired Americredit, its portfolio averaged 17 percent, making it financially attractive for lenders to take on the higher risk involved with subprime loans.
Subprime lenders do not expect the vehicles to appreciate and their loss is limited by depreciation. GM is one automaker anticipating a short-term pickup in the auto industry. The company plans to take advantage of a dip in unemployment by providing bad credit auto financing to a market segment of individuals with poor FICO scores who are returning to the workforce.
