Auto Lending Fraud Risk is Rising
More consumers have become delinquent with their auto loan payments than in years prior, with the total value of past-due loans reaching $23.3 billion dollars, according to the Federal Reserve.
Early payment defaults are a growing portion of this significant problem. In fact, according to PointPredictive Inc., EPD rates (loans that default within the first year without making any payments) can be as high as 3 percent on some lender's portfolios. And many of those defaults have been linked to fraud. Data analysis reveals that between 30 percent to 70 percent of EPD loans contain fraud misrepresentations on the initial application that could have lead to the losses.
Most Auto Lending Fraud is Unknown Today
The problem with auto lending fraud is that most losses are due to first-party fraud where borrowers, dealers or fraud rings lie about the income, employment or collateral value or perpetrate a straw borrowing scheme—when someone else’s name and financial history is used to purchase a vehicle that they do not plan to own and possess. These are hard to detect, and so they often go unnoticed in the origination process and in many cases are never detected, even when the loans inevitably default.
Known fraud is identified either before an auto loan is originated or shortly afterward, when a borrower notifies the lender of identity theft or a lender discovers the fraud in its collections process. Known fraud is more common than you might expect, present on approximately 0.30 percent of originated application volume.
Unknown fraud is sometimes never identified—not during the application process and not even after a loan has been funded and defaults. This fraud, in most cases, results in early or first-payment default. This occurs when the borrower never makes a payment on his loan after walking out of the dealership or becomes more than two cycles delinquent within the first six months after the loan term begins.
PointPredictive estimates that approximately 67 percent of auto lending fraud is unknown today, presenting auto lenders significant room for improvement.
Losses are Reaching Highest Point in 10 Years
Auto lending fraud losses have reached their highest point in the last 10 years. Several factors are driving this increase:
- more active fraud ring activity with new schemes, such as leveraging synthetic identities;
- an increase in overall lending volumes and auto sales over the previous year;
- an increase in lending volumes to higher risk, non-prime borrowers; and
- an increase in fraud misrepresentations linked to EPD as some dealers try to push bad loans to lenders.
This graph indicates the trend of auto lending fraud losses in the last 10 years, according to data analysis by PointPredictive.
Look Beyond Credit Risk to Fraud Strategy
As losses mount, credit unions need to look beyond their credit risk strategies and into their fraud strategies. Here are three ways credit unions can avoid auto loan fraud, and three things credit unions should tell their members and dealerships to do to prevent fraud:
3 Things Credit Unions Can Do to Prevent Auto Loan Fraud
- Do not rely on a credit score to detect fraud. When fraud losses increase, credit unions often try to address the problem by adjusting the qualifying credit score threshold. But credit scores only predict creditworthiness; they do not detect fraudulent behavior.
- Use a comprehensive consortium-based fraud score to identify loans that may contain misrepresentations. A consortium consists of lenders sharing loan application and outcome data to identify fraud trends.
- Join a consortium to share/identify risky auto dealers and fraud rings that submit multiple fraudulent loans across a variety of lenders.
3 Things Consumers Can Do to Prevent Auto Loan Fraud
- Review the contract for phantom add-ons you did not authorize (e.g., does your new car actually have upgraded wheels, turbo or leather interior?) An unscrupulous dealer might be artificially inflating the value of the car (and the loan amount).
- Make sure you review the application in detail and pay attention to the income and employment information provided. Make sure it is accurate and matches the information you supplied to the finance manager.
- Do not agree to be a “straw borrower,” allowing someone to use your name and financial history to secure the auto loan.
3 Things Dealerships Can Do to Prevent Auto Fraud
- Check if the buyer’s stated income makes sense (e.g., he or she works in a fast-food restaurant and claims $20,000 monthly income).
- If you are suspicious, check employment and income discrepancies by requesting bank statements. Cross-reference paystubs against deposits to look for inconsistencies. Confirm prior income using tax records by going directly to the IRS with a 4506-T form to verify the income reported last year.
- Monitor each finance manager’s book of business weekly to identify unusual trends, spikes in volume or a rash of atypical borrowers getting loans in a short period.
A dealer’s role is more critical than most would think in identifying and preventing fraud. Credit unions place a lot of trust in finance managers to give them the correct information. However, finance managers or dealers can send false information to get the deal approved. PointPredictive examined auto loan fraud rates throughout the course of a month and found that pressure to sell more cars might be linked to fraud, too: Fraud rates are 56 percent higher in the last week of the month than they are in the first week of the month.
Becoming more aware of auto lending fraud is the first step to thwarting the problem. Credit unions now need to take proactive action by incorporating fraud prevention solutions and sharing auto lending data in a consortium to truly be part of the solution.
Frank McKenna is chief fraud strategist at PointPredictive Inc. McKenna is an advocate for fighting fraud and has worked with more than 150 banks, lenders and companies throughout the world designing strategies, solutions and operational practices that help them reduce costs and increase efficiencies. Connect with him on Twitter @frankonfraud. For information about the Automotive Lending Fraud Consortium, an industry collective aimed at tackling the problem of auto fraud through collaboration, email email@example.com.