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Capturing the Nonprime Craze

January 2007, F&I and Showroom - Feature

by Becky Chernek - Also by this author

Nonprime and below nonprime sales have come a long way in recent years. In the past, the “buy-here-pay-here” lots were jammed with customers with delinquent credit records. These dealers would absorb the risk of in-house financing for this buying segment by charging half down on a vehicle’s purchase price and an astronomical interest rate until the vehicle was either paid in full or repossessed. Such transactions were always considered a high-risk gamble, but the steep potential gain was what kept these dealers in the game. Now, with new-car sales on the decline, franchise dealers, who dismissed the business as too risky, are quickly opening their eyes to this buying segment. Capturing this potential profit center, however, will take more than a change of heart.

The change in attitude among dealers began around 2001 when subprime loans were accrued and compared with prime-rate loans. Delinquency rates on these obscenely high loans were far lower than anyone expected. Anne Kim, director of the Work, Family and Community Project at the Progressive Policy Institute, learned that Household Finance Corporation, one of the nation’s largest subprime financiers, serviced nearly $6.4 billion in auto loan receivables in fiscal year 2001, more than double the amount serviced only two years before. She noted that delinquency ratios during that recording period varied between 1.77 and 2.89 percent, comparable to the 2.4-percent delinquency rates at the prime-rate General Motors Acceptance Corp.

The findings also caught the attention of banks and financial institutions, which also wanted a piece of the action. They realized that many individuals with slow pay histories were not purposely negligent, but were simply unable to pay for reasons beyond their control (e.g., a death in the family, a sickness, an accident, loss of employment or divorce). Many more were perfectly able to meet their car loan responsibilities if they could only get an interest rate that would not put their ability to pay bills on weekly wages at risk.

Capturing the situation was Eric Heitfield and Tarun Sabarwal’s published study, entitled, “What Drives Default and Prepayment on Subprime Auto Loans?” Without definitive data on the size of the growing subprime automobile loan market, it revealed that the principal outstanding on loans in pools securitized by companies specializing in subprime lending stood at $30 billion at the end of 2001. The two also pointed out that borrowers faced with the high monthly payments associated with high interest rate loans may have more difficulty making regular loan payments. Armed with this information, an increasing number of banks felt the subprime business was worth the risk, especially with literally millions of customers hoping to reestablish their credit and enjoy a new ride in the process.

The below nonprime business took on new meaning and many franchised dealers lifted their heads out of the sandbox to this new way of increasing sales and profits. And how could they not; the competition was outselling them by two to one. With new car sales dipping and little income to be generated from the front-end, they finally saw the subprime business as a great opportunity to maximize lost profits and sales. They could imagine the dilemma of having a slow pay history and finally being given the opportunity to purchase a new car on credit. While once-shunned customers accepted that a subprime loan would require them to pay a substantially higher interest rate than the norm for prime-rate buyers, the rewards of buying a better car from a more reputable dealer would be worth it. The incentive for them to meet payment deadlines would be greater, too.

Energized about this new income possibility, many dealerships opened separate departments to house their subprime business to lessen any possibility of a negative impact on their conventional sales. They hired a finance manager dedicated to working the subprime business and then signed up with various banks to finance their customers. Some were savvy enough to realize that their used-car inventory needed to be adjusted to accommodate the advances on subprime credit calls. They expected to sell more cars and bring in higher profits, and they have. But for many dealers with 20-year-old sales processes, the change hasn’t been so easy. Why? The system won’t work if the subprime department is treated like a gratuitous stepchild — kept secret and hidden away from the heartbeat of the dealership.

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