Your financial institution checks all the boxes: Reducing risk, protecting borrowers and generating non-interest income. With a suite of services, every possible scenario has an offering to match:
- Full comprehensive auto insurance (or force-placed CPI)
- Payment Protection
- Vehicle Service Contract
Seems like you’ve covered it all.
Except…what about protecting against Depreciation?
It’s more than just a GAP claim driver.
Depreciation creates risks for borrowers. It also provides a lucrative opportunity for your institution.
One which lets you shield your borrowers from the worst effects of depreciation. And providing a much-needed loyalty bonus if they should find themselves in a total loss situation.
Depreciation Coverage: A New Loyalty Solution
What’s the problem?
Your borrower just closed a loan on a brand new Ford F-150. They paid $50,000, out the door. By the time she pulled into her garage, it was worth about $45,000.
No fender-benders along the way.
The truck still looks (and smells) showroom new! According to CarFax, there’s a 10% depreciation in value just for taking possession. Crazy.
It gets worse. Edmunds claims her F-150 will lose 28.6% ($14,300) of its value in the first year!
This accelerated depreciation in recent years has led to financial problems for both consumers and lenders. It’s what we’re here to examine in detail.
First, let’s take a look at the factors causing this depreciation.
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What Drives Depreciation?
1. Upfront costs
When a consumer buys a new vehicle, everything gets paid at once:
- Sales Tax
- Documentary stamps
- Dealer fees/commissions
- Insurance add-ons
Looking at that F-150, these expenses could account for 10% or more of the short-term depreciation.
How much is the iPhone 4 worth today?
Not much. And that came out in 2010!
The issue becomes even more laughable if we look at flip phones.
That’s the challenge manufacturers face with today’s cars. Why? Cars are now rolling supercomputers, with a similar pace of obsolescence.
Despite reliability far better than in the past, they now receive judgment based on equipped technology. Anyone here remember their 8-track tape player? (I mean, I don’t, but my dad has fond memories until they got stuck.)
We’re way past that now.
Fine wine and you, our wonderful reader, improve with age.
Car value? Not so much.
It’s one of the two primary factors driving depreciation. Older models have less value, technology improvements aside. However, how old matters.
The first year is the biggest hit. Depreciation levels off in years two and three, with a rise again in the fourth year.
Why? On most cars, this is when the manufacturer’s warranty expires, along with the potential need for new tires and brake service. These costs factor into the depreciated value.
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Success follows finishing a long race. Cars feel differently about those added miles.
The odometer is the other primary depreciation factor.
An average driver covers 13,476 miles annually, according to the U.S. Department of Transportation’s Federal Highway Administration.
Almost without fail, the bigger that odometer reading, the greater the depreciation.
5. Consumer perception
That fine handbag carries value due to others considering it a fine handbag. Some cars, especially luxury brands, elicit the same esteem by consumers. Their perceived value is higher, so the vehicles see reduced depreciation.
I’m a huge fan of cars which just keep working. It’s a common sentiment. Therefore, vehicles with better reputations for reliability see lower rates of depreciation. That applies industry-wide and also within model classes.
Oh no! Your borrower has an accident.
Hope everyone is ok.
After inspection, their insurer pays the claim. Repairs proceed, and now the car looks and drives like new.
Unfortunately, the vehicle now has an accident history which brings along a “diminished” value. Doesn’t matter how good a job the mechanics did; the car is worth less.
To protect against this, some auto insurance companies offer “diminished” value as part of their policies or options.
Yes, you’re right. Accidents aren’t technically a cause of depreciation on any single vehicle.
However, when combined with the technologies (recall #2) prevalent, even small collisions result in high-dollar repairs. This makes a “car with a history” experience greater depreciation.
Take a look at what your car might be worth, based on these examples:
The Financial Effects
Remember that borrower who jumped into her new F-150? Say she bought it with a $10,000 down payment, financing the remaining $40,000.
Towards the end of the first year, the truck was totaled.
The insurance carrier looked at depreciation rates and paid $36,000.
The loan balance (assuming a 72-month term at 4.5%) is $34,058. Her bank or credit union gets their loan repaid, and she pockets the enormous remainder.
Wait, did I say “enormous”? Sure, it’s a whole…$1,942. Hmm. That means she’s…out $8,058. Maybe enormous isn’t the word to use.
What can she do now? She had carefully saved to afford that large down payment. It’s not happening again.
In our example, your institution gets made whole after the insurance settlement. All’s good. Except your borrower bore the brunt of the financial losses. And they were substantial. How will she feel about her experience with your financial institution? What could you have done to protect her from this situation?
Several companies serve the banking world with unique offerings. The benefits vary, with all seeking to make borrowers whole after a total loss situation.
Some are based on loan balance, while others look to the down payment. Many, but not all, require bundling with GAP.
In fact, one company offers it as a “combined” GAP and Depreciation Coverage.
Whichever approach you take, this protection empowers your financial institution to:
- Protect your borrowers from the financial loss in this situation
- Add a source of non-interest income for your institution, with an appropriate markup
- Drive new loans for replacement vehicles – With some programs, the benefits are typically applied ONLY when applying for replacement vehicle financing with your institution.
Which borrowers are the best fit for a Depreciation coverage plan?
- Financing new or nearly new vehicles
- Short (48 months or less) loan terms
- Increased depreciation rate factors on their purchase
- Those with and, especially, those without a need for GAP
Some depreciation products include ancillary benefits.
These are nice to share, as they help keep your financial institution top of mind (in a positive way) while borrowers are not thinking about the depreciation coverage.
Depending on the company, here’s a few of the perks:
- Travel Assistance
- Concierge Services
- Medical Assistance
- $1000 AD&D
In recent years, several auto insurance companies began offering Depreciation coverage to their customers. Perhaps the best known, due to extensive media advertising, is Liberty Mutual.
Their service provides two kinds of depreciation coverage: New car replacement value and Better Car replacement value.
New Car Replacement Value
This coverage is available only for new vehicles with less than 15k miles. If the vehicle gets totaled under those qualifications, the company will pay for a brand new similar vehicle.
Better Car Replacement Value
This is available on older, higher mileage vehicles. In the event of a total loss, the insurance company will pay for the cost of a similar vehicle one model year newer.
Several industry providers offer Depreciation Coverage products to financial institutions.
Each company has different names and branding for their products, so we want to help you understand how they differ.
In addition, they may enforce a range of guidelines for how they are promoted.
Since your goal is to ensure any product is the best fit for your institution, here are some questions to ask:
- Is the Depreciation coverage offered as a separate product, or only as part of a GAP offering?
- Is the Depreciation coverage offered in various stated benefit amounts to best fit our borrower’s budget?
- Does the Depreciation coverage pay in addition to GAP or is the total benefit capped?
To Offer or Not To Offer
Should your financial institution offer coverage to protect members against vehicle Depreciation? It’s a question only you and your team can answer, though we’ll do our best to help you get there!
We offer Depreciation Coverage to our financial institution clients. If you would like to discuss if it might be a fit for your organization, let’s set up a chat.
Appreciating Depreciation Coverage
A well-positioned Guaranteed Asset Protection (GAP) program can reduce much of your institution’s risk. It also provides adequate protection for your borrowers.
Depreciation on its own is unlikely to cause a direct loss for your auto loan portfolio. However, it can produce a loss situation for your borrower and could lead to further financial challenges.
Keeping borrowers happy with full wallets is just a pair of reasons why your financial institution may wish to consider Depreciation Coverage.
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