|Many of us that have delved into the world of Buy Here Pay Here (BHPH) have come from a background in the automotive industry. However, we certainly learn very quickly that in many ways selling the vehicle is the “easy part”. The real “make or break” (literally) decisions often come on the finance side – especially at the underwriting desk.|
Let’s face it – repossessions are the worst expense in the BHPH business. So preventing repos should be one of the main goals for which we strive. Effective repo prevention starts long before your collectors start working on the account. Unfortunately many deals are doomed to fail from the moment the loan is approved because of shaky (or a complete lack of) underwriting practices.
One major consideration is whether to operate with decentralized underwriting, or to centralize your underwriting department. Each option has pros and cons. In a decentralized setup, financing decisions can be made literally on the spot, so turnaround time is minimized. While it can occasionally be advantageous to interview the applicant personally, it is sometimes possible for even the most discerning loan officer to be “suckered in” by a well-spoken (especially if combined with good looking) applicant who knows all the “right’ answers in response to the interview questions.
Conversely, while the centralized approach may require more time, it allows your underwriting department the luxury of analyzing the applicant’s information as objectively as possible. By being set apart from the customer, there is no chance of them being swayed for better or for worse by anything subjective in regard to the applicant. They look at each deal on an individual basis, evaluating whether the loan should be written, based only on the hard facts before them.
The centralized approach also enables your sales staff to be “the good guy” in the negotiations as they can work alongside the customer to try to put a deal together that will be acceptable to the loan office. Not to mention, there are some substantial economies of scale that can be gained if you have a multi-lot operation and you can transmit all applications to one central office whose sole focus is preparing and underwriting the apps they receive from all locations. Above all, the centralized approach provides your operation with consistency, as each applicant goes through “the funnel” the same way, and decisions are made by the same person (or people, depending on your volume), rather than having each sales manager (or salespeople in some cases) making their own loan decisions (Isn’t that like having the fox guard the henhouse??)
Another key decision that must be made is whether to focus on a strict down payment/cash in deal model or rely more on a stability/ability model. The first approach essentially goes back to the roots of BHPH, where down payment was the overriding factor as to whether a loan was approved. If the amount of down payment a customer gives meets the criteria you have set for that vehicle, normally based on how much you have invested in it, then the deal rolls. Obviously, if you are in an area with a large average down payment, or if you are selling relatively low ACV units, you can make this model work. Unfortunately, most of us aren’t in that situation. In addition, from the research we’ve read, and our own first-hand experience, down payment is simply not an accurate predictor of whether a customer will pay. If you don’t believe us, check your static pool charge-off rates from loans written during tax season months!
Instead, we broaden the scope of what we examine on each deal to try to determine the likelihood of the loan making it to term (not just the breakeven point), and focus our underwriting attention on the stability of the applicant and their ability to repay the loan as agreed.
There are a few key figures that should be analyzed when determining if the proposed car payment is affordable for your applicant. One is the debt-to-income ratio. From our experience, total debt (including this proposed car payment) of less than 50 percent of net income is a good benchmark to use. Another indicator you might consider is the payment-to-income ratio. Generally, 20 to 25 percent of net monthly income should be your maximum limits for PTI.
Another good way to look at the affordability of an applicant is to check their disposable income amount. Basically, take their total household net monthly income, and subtract their housing expense (rents or mortgage), proposed car payment (and an approximate car insurance payment if you require full coverage), and any other debts you are aware of from interviewing the applicants or that appear on their credit report (this is the main reason to pull a credit report, yes, even on BHPH customers). Ideally, we like to see $600 per month for the first person in the household, then an additional $150 per month for every additional member of the household.
Keep in mind that the numbers mentioned above could vary from dealer to dealer and area to area. The important thing is to recognize the value of evaluating your applicants overall ability to repay the loan. After all, the BHPH graveyard is full of dealers who “sold” themselves right out of business, without watching their cash flow and properly disciplining themselves to selecting the most qualified BHPH customers available to them. And we certainly don’t want anyone who reads this magazine to someday have an epitaph that reads:
Here lies XYZ Motors.
Vol 2, Issue 9
A record year for dealer participation programs pushed CNA National past the $500 million mark in distributions since the company’s inception.