When it comes to successfully selling a vehicle and getting it financed, particularly for subprime borrowers, dealers and automotive finance companies should heed the advice of former President Reagan and “Trust, but verify.” What we are seeing in the market, however, is that as subprime auto lending continues to grow at record-setting levels, most dealers and finance companies are still relying on traditional credit scores and customer-reported information to deliver and finance loans and leases.

Unfortunately, these traditional verification procedures simply are not the most accurate or transparent way to assess a borrower’s qualifications. Credit scores reflect only a portion of the applicant’s full picture related to his or her creditworthiness.

With insufficient detail, the wrong terms or risk level could be placed on the deal, denying qualified applicants or inadvertently approving excessively high-risk borrowers.

Additionally, applications frequently contain inflated or misrepresented employment and income information, and verifiable insights into historical job tenure and disruptions (which can be highly predictive of ability to pay) are typically not included or — at best — inaccurate. This can lead to heightened risk of loan default, and put dealers at risk for loan buy backs from the finance company.

Because underwriters and funders are usually working to close deals as quickly as possible, they may attempt to manually verify income and employment if they feel it is needed, but this is highly inefficient and often fails to properly identify any inaccurate data.

More recently, rigorous guidelines and regulatory enforcement by the Consumer Financial Protection Bureau has compounded the need for more accurate and comprehensive verifications to ensure good business practices between dealers and lenders, and provide reliable audit trails that establish accountability and compliance.

According to Scott Lilja, senior vice president with the National Independent Automobile Dealers Association, “As a national trade association representing a major segment of the used-vehicle retail industry, we much support full transparency and use of relevant, timely and high quality data to ensure the auto finance process is as objective, thorough , risk averse and compliant for all parties involved. We highly encourage our members and the auto industry at large to embrace risk mitigation solutions that represent the highest standards of fair and transparent automobile sales transactions."

While the industry is seeing improvement in this regard as borrower information is becoming more easily accessible with the consumer’s consent, the top three reasons for vehicle loan returns remain:

1. A lack of verification of stated income;

2. Missing or inaccurate documentation to meet stipulations; and

3. A failure to meet approval terms and contracts that are out of policy.

Verifications sourced through an objective, independent database provide greater accuracy, accountability, transparency and detailed insight into borrowers’ qualifications while also providing operational and service level improvements.

Furthermore, database-supported verifications result in more consistent reliability, and increased efficiency and security by ensuring centralized, replicable and streamlined processes. This is accomplished by compiling and managing unique income and employment data that is updated with each pay period. This data reduces risk and mitigates fraud while enabling lenders to refine risk-level assignment and loan pricing, and reduce stipulations to more accurately reflect applicants’ credit-worthiness.

Recent Studies Illustrate the Significance of Verification

Equifax recently compared database-supported verifications to traditional internal verifications to demonstrate just how practical — and ultimately profitable — database verifications are. The studies looked at the impact of four specific attributes on borrower credit-worthiness:

• Income

• Employment tenure

• Pay frequency

• Employment disruptions

Each of these attributes helps create a more complete context in which to interpret credit ratings. Lenders can also develop a more dynamic understanding of each applicant’s individual circumstances.

The research from the different studies compared a random 10 percent sampling from The Work Number database to traditional credit bureau reporting and verification processes. It examined 90-plus DPD (days past due) delinquency rates from September 2012 to September 2013 for vehicle loans originated in 2011, 2012 and 2013. VantageScore 3.0 was used to quantify performance differences between The Work Number and traditional bureau data.

Income: Specific Levels Predict Specific Loan Performance

The research not only revealed that higher wage earners are less likely to default, but also that the risk of delinquency is reduced approximately 50 credit score basis points for every $10,000 salary increase for individuals earning $10,000 to $80,000 annually.

Furthermore, borrowers earning $10,000 to $20,000 annually were 10 times more likely to go 90-plus DPD on their monthly payment than those earning $100,000 or more.

The research also showed that database verifications identified more than twice the number of applicants overstating income compared to internal verifications. Around 80 percent of lower income applicants inflated their reported income, while approximately 75 percent of applicants earning $50,000 or more under-reported income. As a result, a large number of prime rate borrowers qualify for better terms over the life of their loans, leading to increased customer satisfaction and retention.

Pay frequency is also an important factor, as the research revealed that even highly paid hourly employees are less likely to stay current with loan payments than those who are salaried but paid less. In fact, salaried applicants are twice as likely to stay current with auto loan payments as hourly workers.

Ultimately, verifying income and pay frequency reduces delinquency risk and is essential when defining suitable loan rates and terms. In turn, better quantifying the probability of default enables lenders and dealers to develop more accurate strategies while improving overall portfolio performance as deals are structured to reflect the most realistic repayment scenarios and can be tailored to the most probable estimates to ensure a borrower’s likelihood of keeping payments up to date.

Employment Tenure: Over-Reporting Is High

Based on the findings of the studies, the number of applicants with less than one year of tenure is typically under-reported by more than 150 percent. In the subprime population, borrowers with less than one year of tenure and loans of less than $15,000 are nearly twice as likely to become delinquent than those with 10 or more years.

In addition, borrowers in the general population with less than one year of tenure are three times more likely to go 90-plus DPD than employees with 10 or more years.

In order to gain a comprehensive understanding of a prospective borrower’s circumstances, data generated from database verifications must be combined with employment history. Traditional credit scores neglect job tenure data, but verified tenure can prove effective in mitigating poor performances of small loans and short employment periods.

Employment Disruptions: Immediate Identification is Key

As one might expect, loan applicants and current customers who have recently lost their jobs present greater risk than if they were still employed. With automated verifications, finance companies and dealers are able to identify gaps in employment history that have not been reported accurately while immediately identifying that a new employment disruption has occurred.

Because database verifications include data that is updated each time reporting employer’s process payroll, job disruption can be detected almost immediately. This represents a significant improvement over relying solely on information from credit reports, as that information only indicates the consequences of lost income well after employment has ended.

Early detection also creates opportunities for lenders to respond quickly, and proactively can protect margins by enabling finance companies to intervene with borrowers before payments become delinquent and issues with other creditors arise.

In the event that such intervention is unsuccessful or impossible, appropriate account management strategies can be developed in a timelier manner, and lenders can better partner with their customers to avoid default and improve the relationship instead of creating an adversarial environment.

Identifying and Accommodating the Right Customers

As with any type of analysis, the more specifications that are available, the more detailed and customized the results can be. With multiple data sets, finance companies have much greater insight into loan performance, and the characteristics that identify the customers that align with their target risk profile. Understanding the risks posed by a wide range of income levels means deals can be more appropriately structured to mitigate risk.

Coupling that data with traditional credit scores allows lenders to better customize deals that more accurately reflect the borrower’s personal history.

Combining additional segmented data on pay frequency, tenure and job disruption means gaining even further insight into the financial status of individual borrowers, and that introduces the possibility of eliminating stipulations, offering more favorable terms and improving underwriting efficiency. Bottom line — verified income data doesn’t just facilitate more deals, but identifies the most appropriate deals.

In a time when the subprime vehicle market is booming, dealers and finance companies can no longer rely on traditional credit scores and customer-reported information to sustain healthy and transparent loan portfolios. More accurate, timelier data means more profits and less risk. The wisest dealers and lenders will leverage database-supported verifications to do so.

With verifications supported by a database, dealers and lenders are empowered through greater accuracy, accountability, transparency and detailed insight into borrowers’ qualifications to make more informed, proactive decisions; customize more deals to the benefit of the finance company, dealer and customer; improve customer satisfaction; and increase the number of approved deals.

Jennifer Reid is the senior director of product marketing for Equifax Automotive Services. Reid can be reached at Jennifer.Reid@equifax.com.