Auto Loan Borrowers May Be Gaming Their Credit Scores, UBS Says

  • Lenders may be relying too heavily on the ratings, UBS says
  • Borrowers’ grades have been rising, while lenders loosen terms
Photographer: Patrick T. Fallon/Bloomberg

Consumer credit scores may end up being a lousy predictor of U.S. borrowers’ ability to repay their car loans, according to UBS strategists, citing flaws in the scores similar to those that emerged during last decade’s housing bubble.

As many as one in five auto-loan borrowers admitted in a survey that their applications for debt contained inaccuracies, UBS strategists led by Matthew Mish wrote, meaning fraud could be more pervasive than lenders planned for. A growing number of borrowers have searched on the Internet for “credit score,” signaling that borrowers may be getting better at figuring out how to game their credit scores, the strategists said.

The report raises questions about one of the key arguments for investors not worrying about consumer credit, and car loans in particular: borrowers’ credit scores are broadly rising, and have been higher for recent auto loans than they were before the financial crisis. Those scores have been climbing while auto lenders loosen many loan terms, including allowing longer payback periods, the strategists wrote.

“Everything but credit scores have been eased in lender underwriting,” Mish said. “Loan terms are stretched out, interest rates are aggressive, but there may be an over-reliance on credit scores, and that’s the danger.”

Using Tricks

Consumer credit scores, which date back to the 1950s, typically range from 300 to 850. A borrower with a grade below 620 is often considered subprime. Some lenders and analysts viewed the scores as problematic after last decade’s housing bubble, when their accuracy in predicting the likelihood of a borrower defaulting slipped. 

Part of that declining accuracy may have been because consumers became more adept at using tricks to boost their scores. A 2015 academic paper that looked at mortgage borrowers’ pre-crisis behavior found that “applicants have an incentive to manipulate their credit scores whenever they perceive that the marginal benefits in terms of more favorable loan terms exceed the marginal costs of raising scores." The paper concluded that lenders, which use a mix of other ratings systems and data, relied too much on credit scores.

UBS cited the paper in its note this week, and said the findings were relevant to other kinds of consumer loans. “Simply put, the common comparison of credit scores over time is not a robust measure of risk trends,” the strategists wrote. The strategists surveyed auto loan borrowers about their non-mortgage debt, including student loans, credit cards, and car debt.

Credit scores are usually just one component of a lender’s underwriting process, which also includes scrutinizing the borrower’s employment status, income, assets and other debt. Much of this information is reflected in credit bureaus’ scoring systems.

Worries over fraud and misrepresentations in consumer loans have grown in recent months as delinquencies and defaults increase on various types of debt. More than a dozen major auto-finance companies met last month to discuss rising levels of fraud at the headquarters of subprime lending giant Santander Consumer USA Holdings Inc. in Dallas. Executives at a fraud-detection firm that participated in the event said they’re seeing auto fraud rising, perhaps to levels similar to mortgage applications during the housing bubble. 

“Something is definitely going on under the hood,” said UBS’s Mish in a telephone interview on Wednesday. “It’s not just smoke and mirrors anymore.”

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