Credit Unions Unaware of Skyrocketing Auto-Loan Interest Rates

If you're looking for a good deal on an auto loan, credit unions are still a great option. They typically offer lower interest rates than banks, making them a good choice for anyone looking to finance a car.

SoFi has been offering some of the lowest rates around, undercutting banks and other lenders by a wide margin.

Auto lending is a key business for credit unions, and they often outperform their competition. However, their success is especially noteworthy at a time when interest rates are rising and other lenders are pulling back. This is attracting attention across the consumer-lending market.

According to credit-reporting firm Experian PLC, credit unions charged an average interest rate of 5.94% on used cars in the third quarter, well below the 8.36% on offer from banks.

The gap between credit union and bank rates for new cars is the widest it has been in at least five years. Credit unions are charging 4.43%, while banks are charging 6.06%.

"They kept rates low when the rest of the market just exploded," said John Toohig, who trades credit unions' auto loans as head of whole-loan trading at Raymond James. "That allowed them to pick up market share and grow their portfolios."

Credit unions are not-for-profit cooperatives that are owned by their members and don’t pay federal income taxes. In recent years, they have grown rapidly, and in some corners of consumer finance they are competing with banks. Their profits go back to members, partly in the form of lower borrowing costs.

Credit unions that offer free loans could face difficulties during an expected recession next year. If Americans lose their jobs, they may have difficulty paying back their debts. Delinquencies on subprime auto loans have been increasing rapidly in recent months, but analysts say credit union loans have generally performed well in the past.

Nick Honko, a doctor in Charleston, S.C., shopped around at banks and credit unions when he was buying a new car over the summer. He found that credit unions offered a much better deal than banks.

At a friend’s recommendation, he went with Carolina Cooperative Federal Credit Union, which offered him a competitive interest rate for an 84-month loan. He filled out much of the paperwork by hand and mailed it in. He opened an account to become a member and be eligible for the loan.

At first, he was able to use a credit card to make his loan payments and collect cash-back rewards. However, he said that the credit union later started charging for that option. Mr. Honko explained that the interest rate is so low that he actually earns more interest from stowing cash in his high-yield savings account (which currently earns 3.3%) than he pays in interest on the auto loan.

Credit unions have not been as quick to raise rates as other lenders when the Federal Reserve lifted its benchmark rate to combat inflation. Credit unions do not always move in lockstep with capital markets, said Mr. Toohig. In addition, some credit unions have refocused on auto lending now that there is less demand for mortgages, according to William Hunt, senior analyst at Callahan & Associates, a credit union consulting and analytics firm.

Credit unions typically don't pool auto loans into bonds and sell them to investors, unlike finance companies and the lending arms of auto makers. Keeping loans on their balance sheets gives them flexibility to veer away from the rest of the market.

Credit union advocates say that their lack of shareholders means they can focus on customers instead. This allows them to provide better rates and services to their members.

"When interest rates rise, credit union loan rates will usually lag behind the market. However, on the flip side, savings yields at credit unions will often outpace those at other financial institutions," said Mike Schenk, chief economist at the Credit Union National Association.

Credit unions have seen a significant increase in their share of the auto-finance market over the past year. According to Experian, they held 28% of all auto financing in the third quarter, up from 20% a year earlier. This makes them the largest type of lender in the market.

This year, some of the largest credit unions have added billions of dollars worth of auto loans to their books. SchoolsFirst Federal Credit Union grew its total auto loans by 29% in the first nine months of the year. Navy Federal Credit Union's auto loans rose by 13%, and Golden 1 Credit Union's climbed by 18%, according to financial disclosures.

Banks are pulling back on lending, with Capital One Financial Corp. reporting a 28% decline in originations in the third quarter compared to the previous year. This trend is likely to continue as banks tighten their lending standards in the face of economic uncertainty.

Many auto lenders appear to have raised their prices in response to rising interest rates, but some have not, and this has allowed them to gain market share and put pressure on industry margins, according to Chief Executive Richard Fairbank.

If credit unions need to sell auto loans to free up space on their balance sheet, they may take losses. This is because the interest rates on the loans are lower than current market rates. According to Mr. Toohig, some credit unions are finding that auto loans that traded at 101 or 102 cents on the dollar at the beginning of the year are now trading at 95 to 96 cents on the dollar.

When Jennifer Lapsker, a dentist in Albuquerque, N.M., was shopping for a new Tesla over the summer, she decided to finance her purchase through a credit union. She had heard that credit unions offer the best rates, and she was able to get a rate of about 4% for her new Tesla.

In September, she took delivery of a car after getting a loan from Nusenda Credit Union at a rate of 2.55% for 60 months.

"I was surprised to hear about the low interest rate," she said. "It seemed too good to be true, but I decided not to question it."