Common Myths About Subprime Lending

When lenders target and serve consumers with a low credit score, it benefits the economy in multiple ways. It enables consumers with subprime scores (those with a VantageScore 3.0 of 300 to 600 at the point of opening a loan or credit product) to use credit to meet their financial needs and to build a healthy credit history if they make payments in a timely fashion. Consequently, this enables lenders to operate profitably so they can continue to offer credit to those in need. This phenomenon creates a loop of healthy credit access and credit supply, and contributes to our overall economic growth.

However, there are common myths about subprime lending, partially driven by the financial industry’s painful experiences in the last recession^[1]—the underlying drivers of which are too many to be pointed out in this article. In this series, we will debunk or prove some of those hypotheses about subprime consumers in the U.S.

Here are the four myths we will explore, leveraging TransUnion’s market intelligence solution, Prama:
Myth 1: Subprime lending has grown exponentially since recovery from the last recession.
Myth 2: Subprime consumers are served by specialty/non-traditional lenders only.
Myth 3: Subprime borrowers have difficulty improving their scores over time.
Myth 4: Thin-file^[2] subprime borrowers, who enter the market for their first card or first loan on file tend to perform significantly worse than those with a thick credit file.^[3]

First, let’s explore myth 1:

As expected, growth in subprime lending gained momentum after we recovered from the recession. Consumers had regained economic stability to make payment obligations — thanks to favorable and improving employment trends. And, lenders strategized to invest capital in profitable segments to grow assets prudently.

Using Prama, we see that since hitting a pre-recession peak of almost 25 million subprime credit cards opened in 2007, we still have not observed origination volumes return to this level. In 2016, subprime credit card openings reached 21.3 million — the highest observed since post-recovery era. In the subprime auto finance world, 2007 marked the year of highest observed subprime loan and lease originations at 4.3 million. Since then, subprime auto lending peaked at 4.4 million subprime loans and leases in 2016.

Subprime unsecured installment loans have experienced significant growth at about 6% CAGR since 2005, according to Prama. The underlying drivers of subprime lending in the personal loan market are primarily driven by the growth in new entrants serving this segment, which we will cover in further details while proving or disproving the next myth.

While the myth is real because subprime lending has been on the rise (as depicted in the graph above), specifically for the credit card, auto finance, and personal loan market, it is important to note that last two years have demonstrated a slowdown in that trajectory. A rather stable trend persists since 2017, which indicates that lenders serving the subprime segment have recently stabilized that access to a specific threshold or norm that delivers a desired risk-return dynamic. This leads us to the topic of identifying trends within specific lender segments that serve the subprime consumers in the U.S.

Myth 2: Subprime consumers are served by specialty/non-traditional lenders only.

Many believe that higher-risk consumers are only served by specialty lenders such as traditional finance companies, payday lenders, and other nonbank institutions. To prove or disprove this hypothesis, we observed the past seven years of subprime loan originations using Prama and segmented by different lender segments that finance installment loan products.

In the auto finance market, independent lenders finance a major share of subprime loans. But auto captives and credit unions own a decent portion of the market share, and have maintained this share over the last seven years.

FinTechs have gained significant share since they entered the unsecured personal loan market. However, with pressures on returns, we have observed a shift towards lower risk segments. Despite that shift, FinTechs’ share of subprime personal loans has remained high and steady over the last two years at 26%. Traditional finance companies, such as non-deposit financial institutions, continue to own majority of the market share of subprime borrowers with unsecured installment loans.

While the hypothesis may stem from these market share statistics, it is critical for consumers to be educated about the various options available from different types of financial institutions that serve subprime credit needs. These lenders work closely with TransUnion to leverage trended data that enables them to better understand consumers’ payment behavior over an extended period of time and not just a point-in-time credit score. TransUnion has enabled lenders to incorporate enhanced scores such as CreditVision® that help identify a consumer’s true inherent risk. This enables lenders to offer credit and empower consumers who are creditworthy.

While access is important, lenders should serve subprime consumers to support the healthy economic growth phenomenon mentioned earlier in our conversation. In our next blog, we’ll address the myths around subprime performance trends.

Learn how you can understand subprime consumer behavior, identify growth opportunities and improve portfolio profitability with Prama.

¹ According to the National Bureau of Economic Research, the recession in the United States began in December 2007 and ended in June 2009, thus extending over 19 months. 
² Thin-file borrowers are consumers who have less than 4 trades on file.
³ Thick-file borrowers are consumers with more than 4 trades on file.