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.
Plowing The Field
Any dealership can add this important division to its finance department. But first, the task of research and careful training of personnel must be initiated. Working with subprime customers is not the same as working with prime-rate customers. The entire dealership staff must be on the same page if the venture into below-nonprime financing is to be successful. The only way to prepare a subprime department is through rigorous and proper training. It’s like plowing the field and fertilizing before reaping the harvest. It starts with learning how to greet and qualify subprime customers. Customers must be cordially and correctly greeted on the lot, and every salesperson must be trained on the specific word tracks that elicit the necessary information. Monthly payments, sale prices, discounts and down payments are never discussed at this time, but information regarding the customer’s ability to qualify for a “buy” is mandatory. An effective salesperson will know how to build rapport while moving through the qualifying questions at the same time — a process that should never sound like an interrogation.
Using qualifying questions should help the salesperson determine if the customer can buy, if certain red flags indicate a slow-pay credit rating, and what particular vehicle the customer can afford based on job stability and status. If management determines the customer is subprime after the sales negotiation process was initiated, it’s truly a tall order to turn the sale around. That’s why suitable and extensive training of personnel is a must if any dealership wants to be profitable in the subprime business.
The Not-So-Subtle Sabotage of Nonprime Profits
Sales managers must be trained on subprime financing, as the process cannot be left solely up to finance managers. Why? Sales managers who aren’t trained will destroy profits and sales, which is why it is essential they know how to work and structure sales prior to negotiating payments and terms with customers. For instance, they cannot charge customers the acquisition fee that is obtained by the bank. Dealers must “eat” this cost because it is illegal to add the acquisition fee to the customer’s cost once the transaction has been negotiated.
Many untrained sales managers also tend to work the deal without pulling credit before negotiating terms and payments. And once customers agree to the sale, the sales manager then moves to pull their credit. This is usually too late, however, as the customer typically won’t budge from the payment or terms agreed upon. Although the bank may buy the customer, they won’t buy based on the foolish terms negotiated. This leaves sales managers in a real bind. Either they reduce profit even more to sell the unit, or, in too many instances, lose the sale altogether.
If sales managers assume all subprime customers are gold before their pay-back history has been reviewed, they will sabotage the deal. The customer should be presented with a suggested retail price without discount — 20-percent down with two payment options figured on an average rate factor. Should the customer want to discuss lower payments or different terms, this is a great time for managers to pull their credit to determine worthiness. The sales manager should never be blindsided. Sales managers should take immediate note if the customer is negotiating on the right car once the credit has been pulled. They should never continue to work the deal until the customer is put into the right car for bank approval.
Another reason many sales managers sabotage sales is because some aren’t paid on subprime credit transactions. This means they will continue to work their deals until all the profit is spent before they turn them over to the subprime department. Their customers are worn out and confused and the excitement over the possibility of buying a decent car is over. The subprime manager has nothing left to offer them. If any deal is made at all, there is generally minimal profit. A properly trained sales manager will not let a pay plan destroy efforts in the subprime department.
Any dealership getting into the subprime sales business can increase profits and sales if a consistent sales process on the floor is wisely implemented. Sales personnel must all be included in the training and know-how equation. They must become experts in managing subprime customers and in knowing what questions are important from the meet-and-greet stage to the first presentation of numbers. They must know the importance of pulling credit history prior to negotiating terms and rates. If they start the deal with a consistent pricing strategy and offer payments that utilize an average interest rate factor, the dealership will realize more car sales and more profit.
What’s the payback? Subprime borrowers who have dealt with shady roadside dealers selling fewer cars for more money and at much higher interest rates will have a strong incentive to rapidly prepay your good-faith and fair loan . . . even at subprime rates. Will your dealership reap a bountiful harvest? As Sam Walton, founder of Wal-Mart, said, “High expectations are the key to everything.”