PenFed Credit Union will begin offering members a balloon auto loan this summer that removes one of the biggest risks these loans pose for borrowers: Having their cars repossessed because they can’t afford the final payment.
Consumer advocacy groups are leery about current balloon payment auto loans, comparing them to the balloon mortgages that triggered many foreclosures during the housing bubble preceding the Great Recession.
The loans are designed to be appealing for consumers because they have significantly lower initial monthly payments – which consumers pay a lot of attention to – while they have a large, often unaffordable final payment down the road – which consumers tend to ignore or rationalize away.
On conventional balloon loans, if consumers can’t make that final payment, they can refinance, piling on more interest costs, or lose their car through repossession, damaging their credit record.
However, PenFed’s “Payment Saver Plus Program” removes the risk of credit damage, making a walk-away just another option to satisfy the balloon payment obligation.
“They don’t have to risk any negative credit reporting,” said Ivan McBride, VP of auto lending product sales at PenFed, Tysons, Va. ($24.5 billion in assets, 1.7 million members).
McBride said PenFed is trying to work with its mission of serving members, while recognizing that many of its members manage for cash flow, making the size of the monthly payment their top concern when financing a car.
The loan program is facilitated by Auto Financial Group (AFG) of Houston, which has been trying to encourage leasing among credit unions and other lenders by guaranteeing residual values and providing services designed to make leasing a nearly turnkey operation.
A balloon auto loan is similar to a lease in that the final payment is based on the residual value of the vehicle. The larger the residual, the lower the pre-balloon payments that can be offered.
However, betting how much a new Toyota Corolla or a Jeep Cherokee might be worth five years from now involves a level of sophistication beyond the scope of most credit unions.
That’s the space companies like AFG and Fusion Auto Finance based near Fort Worth, Texas, have been working.
In PenFed’s balloon program, AFG will be guaranteeing the residual, contacting owners in the final year of their loan to determine their plans, and handling the remarketing of cars from walkaways.
PenFed will be among the first to offer these types of loans for both new cars and used cars up to five years old, said Joe Leonard, PenFed’s VP of indirect automotive sales development.
“It’s going to be an industry leader in that we’re willing to tackle the used car market also,” Leonard said.
Ivan McBride, PenFed’s VP of auto lending product sales, said the credit union still is predominantly a direct lender for its members. It encourages members to study prices for the car they want and get pre-approved.
They should “not focus on the payment when they step onto a dealership,” he said. “I would first settle on a price with the dealership.”
The walk-away balloon loans are designed for members who are attracted to features of leasing, but want to have ownership of the car without the huge end-term risk of not being able to meet a balloon payment.
“We know the consumers want flexibility in their payment, and we think we’re going to hit the mark with this one,” McBride said.
PenFed plans to roll out these new “Payment Saver Plus” loans through indirect financing starting in Virginia and Maryland in June, then California in July, Florida in August and through direct lending by year’s end.
The rollout will be accompanied by educational material on PenFed’s website, blog and social media.
“We know there’s going to be some education necessary to get consumers more comfortable with what a balloon walk-away product is,” McBride said.