Negative Equity Crisis: How Credit Unions Can Protect Members - and Their Portfolio

Negative equity in auto loans is rising fast with 24.2% of trade-ins for new vehicles in Q3 2024 underwater, and the average negative equity amount hitting a record $6,458 up from $5,808 last year, according to Edmunds. This leaves many borrowers owing more than their cars are worth trapping them in a cycle of rolling unpaid balances into new loans and deepening their debt.

Mission-driven credit unions are in a unique position to help members navigate this growing crisis. By offering tailored products, education, and strategic incentives, they can mitigate the impact of upside-down loans while protecting their portfolios.

Below, we’ll explore how to strategically offer proactive loan restructures versus refinancing and how targeted incentives can encourage members to stay in their vehicles longer, breaking free from the negative equity cycle.
‍

Retention Restructures: A Proactive Approach to Keep Loans and Members

Retention restructures modify the terms of an existing loan to make it more attractive to the borrower without originating a new loan. This proactive strategy isn’t focused on financial hardship but aims to retain members by offering better terms before they look to trade in their vehicle and secure financing elsewhere. Credit unions can use data from their core systems, including LTV ratios and vehicle valuations, or partner with companies like Constant which combines this data and presents the right offer to members at risk of trading in or those with high negative equity.

The goal of retention restructures is to prevent member attrition by extending loan terms to lower monthly payments or adjusting interest rates to market conditions. These offers can be made before a member even requests them, keeping them loyal to the credit union while improving their financial situation.
‍

Refinancing: A Fresh Start for Borrowers with Positive Equity Potential

In cases where negative equity is minimal or where rising vehicle values could soon bring the member back into positive equity, refinancing can be a viable solution. Refinancing is typically offered to borrowers with good credit standing or those who have improved their financial position since the original loan. However, credit unions that don’t regularly refresh FICO scores in their core systems may miss the opportunity to offer better terms before members seek refinancing elsewhere. If there’s ever been a time to keep FICO scores up-to-date, it’s now.

Credit unions can offer refinancing to help members lower their interest rates, switch to shorter loan terms, or adjust their payments to better align with their current financial situation. Given the volatility in auto lending seen in the America's Credit Unions August report, which showed a 1.8% decline in the total car loan portfolio, offering refinancing as a competitive option can help retain members who might otherwise seek better terms from competitors.
‍

When to Offer a Refinance vs. a Retention Restructure

The decision to offer a refinance or a retention restructure should be based on a member's financial profile, their LTV ratio, and the trajectory of vehicle depreciation. Retention restructures are best suited for members who face negative equity but still show signs of financial health. For example, members with an LTV ratio approaching or exceeding 100% but who have been consistent in their payments are prime candidates for retention offers. By offering to adjust their loan terms preemptively, credit unions can help members avoid financial strain and prevent them from seeking alternative solutions that may not be available or favorable due to their negative equity situation.

On the other hand, refinancing is more appropriate for members who are in a stronger financial position and whose vehicles are likely to regain value or who have seen improvement in their credit profiles. Members with lower LTV ratios or those who are only slightly underwater on their loans may benefit more from a full refinance. This allows them to lock in better terms, and it benefits the credit union by securing a new, performing loan while keeping the member in-house.
‍

Incentivize Long-Term Vehicle Ownership

To help members avoid the negative equity trap in the first place, credit unions can offer incentives for longer-term vehicle ownership. One of the primary reasons members end up in negative equity is trading in their vehicles too early, often before they’ve built any real equity. By encouraging members to keep their vehicles for a longer period, credit unions can help prevent premature trade-ins and the accumulation of additional debt.

Credit unions can implement loyalty programs that reward members who retain their vehicles for a set period. For example, offering a reduction in interest rates after three or five years of on-time payments can incentivize members to hold onto their vehicles longer. Additionally, members who reach certain milestones in loan pay-down could receive cash bonuses or fee waivers on other services. By tying rewards to responsible vehicle ownership, credit unions not only help members reduce the risk of negative equity but also foster long-term member loyalty.

Direct Member Incentives for High-Resale Vehicles

Another key strategy is to steer members toward vehicles that are less likely to depreciate quickly. Certain makes and models have higher resale values, making them a safer bet for members concerned about negative equity. Instead of relying solely on dealer partnerships, credit unions can leverage their car buying services and proactively offer pre-approved financing for vehicles that historically retain their value better.

Credit unions can offer lower interest rates or exclusive loan terms for members who purchase high-resale vehicles, such as certain popular fuel-efficient models or electric vehicles (EVs). In today’s market, where NCUA data shows a 4.9% decline in new car loans — the biggest drop in a decade — targeting vehicles with higher resale potential can help members avoid negative equity while maintaining loan growth for the credit union. These vehicles not only hold their value longer, but they also offer additional financial benefits such as lower insurance premiums and fuel costs, making them more attractive to budget-conscious members.

By offering better financing terms for these vehicles, credit unions can promote responsible borrowing and ownership, aligning their loan portfolio with vehicles that are less likely to leave members in a negative equity position.
‍

Monitor and Proactively Engage with At-Risk Members

Data analytics can play a crucial role in helping credit unions identify members who are at risk of negative equity. By monitoring LTV ratios, payment histories, and market conditions, credit unions can proactively engage with members before their financial situations become untenable. Offering early intervention in the form of loan modifications, refinancing, or financial counseling can prevent negative equity from leading to defaults or repossessions.
‍

Leading the Charge Against Negative Equity

The negative equity crisis in auto loans presents significant challenges, but it also gives credit unions a chance to demonstrate their commitment to member well-being. By proactively offering retention restructures to members at risk of negative equity and refinancing to those in better financial standing, credit unions can help their members navigate this tricky landscape.

Furthermore, by providing incentives for long-term vehicle ownership and guiding members toward high-resale vehicles, credit unions can protect both their members and their loan portfolios from the financial risks of negative equity. As member-owned institutions, credit unions are uniquely positioned to lead the way in safeguarding members from these risks while building stronger, more resilient relationships in the process.

‍
About Constant

Constant helps FIs create new revenue streams by automating loan servicing and continuously offering relevant products in digital channels. By moving common servicing tasks to digital banking, FIs empower their customers to resolve requests online thereby reducing call volume and operational costs. Constant helps FIs improve their bottom line by driving new fee and interest income from real-time, relevant product offers and boosting efficiency.

For more information contact press@constant.ai

‍