What’s All This About Protecting Against Depreciation?
This probably isn’t the first time you’re hearing that term. Depreciation coverage is making inroads within the auto lending sector. Naturally, you’re looking for some quality info on it.
- What is it?
- Should our institution offer?
- What are the pros and cons of Depreciation coverage?
These are all great questions. While we cannot say if you should offer it, we can provide all the details you need to make that decision for yourself.
This article focuses on that third bullet point. In fact, any time we present a new product or service to clients, they ask for a pros and cons one-pager.
Is that what you do, too?
So you might be thinking, “we already offer plenty of protection products”. On the auto lending side, that might include:
- Credit insurance (or debt cancellation)
- GAP protection
- Warranty (aka, Vehicle Service Contract)
- Auto Deductible Reimbursement (ADR)
Seems like both the lender and borrower have a wide spectrum of coverage options, right?
And kudos to you and your team for ensuring every borrower is well-informed on these choices. Besides, if we’re talking depreciation, isn’t that what GAP covers? In a word…yes-ish.
It’s actually a great question.
Before diving into the Pros and Cons (and what to consider!) of Depreciation coverage, let’s look at what GAP does and does not do. They’re related, but for different purposes.
Rising GAP claims, inflated LTVs, even increasing depreciation rates can have negative effects on your auto loan portfolio. Keep it above water with our Auto Loan Portfolio Risk White Paper.
GAP Coverage vs. Depreciation Coverage
Guaranteed Asset Protection (or GAP) is a fantastic product which helps protect both your institution and the borrower. As you probably know, GAP is for the gap between vehicle value and loan balance.
Coverage is used if a borrower’s vehicle suffers a total loss and their insurance company settlement is less than the loan balance.
The “why” is simple: No one wants to be paying a loan on a car they don’t have.
However, GAP does not protect the equity in the vehicle. Consider this common scenario:
GAP paid off the loan balance. However, without Depreciation coverage (called TotalRestart by this provider, which happens to be the one we work with), the borrower is still behind.
They don’t get back their down payment nor any built-up equity. Consider why that matters: If you had to save up for that down payment, would you be able to just do it again with no warning?
This borrower now has to take out a larger loan because they cannot subsidize it with a down payment. Sure, the institution makes more, but is it really best serving the borrower?
With the Depreciation coverage benefit, they are best empowered to “start over” and make a purchase with minimal losses.
And that’s the “why”.
Can you see where it may be valuable? Perfect, now you’re ready for the Pros and Cons of Depreciation Coverage.
Pros of Depreciation Coverage
Protects borrowers’ down payment & equity
Take a look at that chart above one more time. As you can see, the borrower can now replace their totaled vehicle with one similar to it.
That’s a big deal, since today, a new car can depreciate anywhere from 11-30% in the first year alone! And much of that happens before you’ve even programmed your favorite radio stations.
It’s estimated that there is a 10% depreciation the moment a vehicle rolls off the dealer lot.
Depreciation coverage can serve a need when there is no GAP.
How many times have your loan officers said, “well, it looks like you have no need for GAP protection, so let’s just move on here”?
In some of those cases, they were surely exposed to some risk.
How can you quickly recognize borrowers with a potential need for Depreciation coverage?
They may fit these factors:
- Have a down payment or trade-in value greater than 20% of purchase price or;
- Have a loan term of 48 months or less
Loyalty pays: May generate new loans
One of the unique features of some, though not all, Depreciation coverage programs is a loyalty criteria.
This means the borrower only receives the benefit if they finance their replacement vehicle with your financial institution.
I don’t know about you, but I’d definitely lean towards the financing which rewards me with potentially thousands in reimbursements!
Additional value-added benefits for the borrower
Besides the basic depreciation benefits, value-added benefits come with the purchase. These ancillary perks serve to enhance the program and provide additional services if and when they are needed.
Some examples include:
- Concierge Services*
- Medical Assistance*
- Travel Assistance*
- AD&D Coverage
* Benefits provided by ON CALL – a provider of travel assistance and concierge services to the travel industry.
Positive borrower experience
Most borrowers understand the purpose of GAP and of having a warranty. As this is a new solution to a fairly recent problem, many consumers will not be aware that they may be at risk.
Your institution has an opportunity to point out the issue and offer an affordable solution, providing even more borrower peace of mind.
In the event of a claim, your borrower will be relieved, if not overjoyed, by receiving the dollars which will recoup their equity and enable them to purchase a similarly priced vehicle.
Generates non-interest income
Depreciation coverage provides your institution with yet another source of fee or non-interest income. This is especially important where a borrower has no need for GAP but does have a need for Depreciation coverage.
More borrowers’ loans can be fully monetized while providing valuable borrower benefits:
- Any Car Replacement Benefit – Helps replace total loss vehicle with a vehicle similar to the one originally financed.
- Available on “Any Car” and for a longer period of time than New Car Replacement programs of primary insurers.
- Provides coverage for Depreciation versus just paying off the loan.
- Helps protect “down payment”.
- Peace of mind if car is deemed a Total Loss.
Cons of Depreciation Coverage
Additional staff training and web updates take time
Yes, there’s no way around this. Your institution must allot time and resources to the following areas:
- Staff understanding of product
- Recognition of Depreciation coverage’s importance to borrowers
- Training in the selling and buying process
Your institution’s online loan platform will also need this service added. Documentation for borrowers must be created and provide necessary benefit and selling points.
May make selling more complex and increase time
Your staff rocks at training and offering services to borrowers.
Another product in that “menu” will get great attention, but it will increase the time and complexity of the loan closing process, if only by a small amount.
The end goal is providing a stellar customer experience, of course. That’s going to take some additional time internally, as well as with any borrowers.
We know you can make it flow smoothly; it’s just important to mention.
More pressure on borrower’s budget and increased risk to lender
When a borrower agrees to the purchase, it will either increase their payment or extend the term of their loan.
Some borrowers choose monthly payments right on the edge of what they can afford.
If this is the case, adding more onto that loan balance may increase the percentage of loans that could go “underwater”, thereby actually increasing lender risk.
Make sure your staff works with the borrowers to determine their budgets.
No risk protection for lender (unlike GAP)
GAP is a risk management tool for lenders. Depreciation coverage is a risk management tool for borrowers. It’s important to note that claims may not pay off any existing loan balances.
This is true whether the program offers benefits based on insurance settlement values or remaining loan balance. If the latter, claim dollars are paid directly to the borrower.
For the loyalty programs, those claim dollars are held by the insurance company until the new loan for the replacement vehicle closes.
The benefit is then paid to the borrower, however, only after the lender confirms the total loss and the new loan.
Additional reporting requirements
Adding another product to the mix may require additional resources to:
- Set up in Loan Origination System
- Ensure connection to core
- Regular reporting to Depreciation Coverage provider
Depreciation is a thing. And it just increased while you read this sentence. It’s absolutely a risk for your borrowers.
The question we tried to help you answer was: Should your institution offer Depreciation Coverage? We think it’s a valuable addition to your portfolio.
Of course, that is up to you to decide. Remember, as noted in What is Depreciation Coverage, borrowers may be able to purchase it through several major insurance carriers.
While there are benefits for your institution, there can also be drawbacks. Only you and your team can decide if Depreciation coverage might be a fit.
Still undecided or just wish to learn more? Check out our other articles on this subject:
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