|We’ll never forget one of the first 20 Group meetings we attended. We went around the room, with each dealer stating what they charged for APR. Most of the dealers were in the 18 to 25 percent range. Then one dealer announced with his perfect Carolina drawl (and an impeccable sense of comedic timing), “I charge two, nine!” He paused for effect as jaws dropped open and eyes bugged out around the room, before continuing, “Yep, two nine…That’s 29 percent!”|
The Buy Here Pay Here (BHPH) industry is full of potential obstacles that, with the proper presentation and consistent processes, can be turned into positive opportunities. An example of this is the decision of how much APR (Annual Percentage Rate, a.k.a. Interest Rate) to charge on BHPH loans.
In BHPH, there are two primary sources of revenue: front end gross on the sales and interest income on the finance side. Certainly as a good businessperson, one of your goals would be to maximize these revenues. Of course, the amount of revenue (Gross + Interest) is also greatly impacted by the amount of payment the customer can afford (as well as the ACV of the vehicle, and the term of the loan for which you are comfortable lending).
For example, if $80 per week is the maximum that the customer can afford, and your maximum term is 156 weeks (3 years), there is only “X” amount of total revenue to be realized on that deal. How to allocate the revenue between gross and interest is a strategic decision that each dealer needs to make. You can choose to charge the state maximum, while making less gross (remember, the payment and term are already maxed), or you can offer a lower rate, maximizing your gross.
Our philosophy is to focus on the gross side of the equation, while offering as competitive an interest rate as possible. In our early days in this industry, we found that while going through the sales process with our customers, we really only encountered two main objections: price and interest rate. By concentrating on the gross side of revenue, we have been able to eliminate interest rate as a point of contention for most of our customers.
If you increase your gross by slightly raising your selling price, and then reducing the APR charged on the loans, you “net out” about the same on overall revenues, but you will have eliminated one of the two major objections you usually have to overcome during negotiations, leaving only price with which to contend. And, as our friends at the Joe Verde Group teach, the price objection can be easily overcome by rephrasing it as a question of “budget”…more on that another time.
Now, certainly there can be some tax advantages to charging a higher interest rate and a lower gross. However, those advantages can be equally attained by utilizing a properly structured Related Finance Company (RFC).
Another luxury that the BHPH dealer enjoys is the ability to offer special interest rates in order to motivate customers towards desired activities. For example, offering clients lower interest rates on a tiered basis, determined by how much cash down payment is received. The larger the amount of cash that the customer will put down, the lower the interest rate they will receive on their loan. It is amazing how often a customer will be able to “find” another $500 to use for down payment when they realize it will result in a 3 percent interest rate reduction.
Another great way to use APR to your benefit is to reduce the interest rate for repeat customers (particularly those that have paid well on a previous loan with you!). Offering rates as low as 9.9 percent for preferred customers can create excitement. Customers will be very excited when they receive a notice in the mail telling them that they are eligible for a rate that is lower than what some banks would charge someone with perfect credit on a similar vehicle.
One word of caution: Logic would dictate that if a lower interest rate is good, then charging no interest (0% APR) would be even better. Unfortunately, most legal experts in our industry would advise against this, as it appears to be a red flag for the Attorneys General and other state organizations that so diligently review our industry, and hearing words like “hidden interest” and “Truth-in-Lending violations” can really ruin your day.
So, as you can see, there are a lot of opportunities in this one area alone, and the sharp dealers (like those reading Auto Dealer Monthly!) will have a big leg up on their competition. This business really is a lot of fun, especially for those dealers who are always on their toes, and never….lose interest!
Vol 2, Issue 9
Lending Tree’s most recent auto finance snapshot finds originations, amounts financed, and monthly payments all accelerated in 2018.