The former coach of the Dallas Cowboys and Hall of Fame inductee Tom Landry once said, “Setting a goal is not the main thing. It is deciding how you will go about achieving it and staying with that plan.” This notion can apply to you and the buy-here, pay-here business. When starting a BHPH department, the goal is simple: Sell a lot of cars and make a lot of money! The question then becomes, how does one do it?
The very first thing you need to do is develop a business plan. It should address initial capital needs, underwriting and collections. Since you won’t be at the mercy of an outside funding source, you can approve anyone you want. But there are several questions you to answer before you make your first approval. How much money will it cost to start a BHPH department? Who should I approve? How will I collect from the buyer?
1. Establishing Initial Capital
“Cash is king” is a very common phrase in the car business, but it is the golden rule in BHPH. That’s because this business model is one in which you can actually sell yourself out of business. If you do not have enough cash, you won’t be able to fund anymore contracts. If you start small and grow over time, it will be easier to determine your capital needs.
As part of your business plan, you need to determine your exposure, or your cash in deal (CID). This is calculated by taking your actual cash value (ACV), including reconditioning costs, state taxes and fees, and subtracting it by your customer’s down payment. For instance, if your ACV is $4,850 plus $500 in taxes, your total up-front cash required is $5,350. In your business plan, if you determine that you want your deals to have a maximum CID of $4,500, then your customers will need to put down a minimum of $850 to stay in line with your business plan.
To determine the cash needed in a month to get your BHPH funded, multiply your CID by the number of cars you plan to sell in a month. When starting a BHPH department, it is best to have at least 24 months worth of cash up front to get going.
One of my clients has a BHPH location that does 20 deals a month. And when the operation hits 20 deals a month, it’s virtually done unless someone has an extraordinary amount to put down. His CID is no more than $4,000, which means the dealership needs $80,000 per month to fund its BHPH business. And if they were starting from scratch, they would need $1.92 million to start.
2. Establishing Underwriting Policies
Underwriting is not an exact science, even though there are several software programs available to help make these decisions more scientific. But there is a method for making credit decisions that doesn’t rely on technology.
The first thing a BHPH dealer needs to do is find out if a customer can afford a new payment. A manager can conduct an in-depth credit interview to determine the customer’s remaining disposable income. Just make sure to base everything off of net income. Additionally, a lot of dealers do not factor overtime into income calculations unless a customer has a long-term job and a proven track record of receiving overtime.
The next part of an underwriting decision will come from a completed credit application. It is important to get all the blanks filled in and to get 10 to 12 references. At least half of those references should be family members.
It’s also critical that you get landlord references, residence and job history for at least the last three years. Once you have that, have someone on your team call the employment and landlord references. Calling those references will give you a better sense of the customer, because if those references don’t speak highly of the customer, it’s highly likely he or she will be a headache for your collections department. Calling references is also a way to make sure the customer gave you the correct information. If the customer lied, then you probably don’t want him or her on your paper.
As you build your portfolio, try to keep your customer base as close to the dealership as possible. You can do this by instituting a policy requiring that customers live within 20 miles or so of the dealership. It is also recommended that your policies require customers to be employed at their current job for six months or within their field for one year.
Lastly, you need to determine the customer’s need for a vehicle. If they have been without a vehicle since the year prior, it is highly likely he or she will return it the first time problems arise. That’s because he or she is used to getting around without one. On the other hand, a customer that will pay more times than not is the one who just had his car repossessed because payments were too high. That’s because he or she relied on that car to get to work.
Additionally, you need to determine how much of a down payment you will require. This is a critical consideration when it comes to your business plan. A big down payment is a good thing, but it does not make a customer a good payer. It is best to setup minimum down payments that get a deal structure in line with your acceptable CID.
To summarize, when writing up your business plan’s underwriting guidelines, it is best that your customers meet these criteria: They can afford it; they tell the truth during the paperwork process; they live in the area; they have a stable job; and they need a car.
3. Formulating Collections Policies and Procedures
Before you spend a penny on starting your BHPH department, you need to realize that you are not in the lending business; you are in the collections business. Anyone in the world can lend money, but it’s only paper profits until it is collected.
That’s why your business plan must contain policies and procedures for your collections department. You need to address every possible situation, including policies for what to do when a car breaks down on a customer, accepting partial payments, making payment arrangements, tracking insurance coverage and handling skip hazards.
You also need to keep in mind that repossession should be a last resort. It is a no-win situation to repo a car. The job of a collector is to build relationships with customers and help them stay on track, even when they get behind. Employees in your collections department need to know how to handle exit interviews, and how to explain to customers that they are there to help them rebuild their credit. In other words, you don’t want the first contact with a customer to be about a late payment. Customers in this credit spectrum need to be trained to budget and to make their payments.
A great way to help train them is with payment assurance devices. They can be great tools for any collections department and will drastically improve collections while virtually eliminate skips. But remember, collections is about building relationships.
4. Staffing a BHPH Operation
Setting targets for initial capital, underwriting and collections are important categories to include in a business plan, but there are other categories that need to be addressed as well. How many people will you need to run the new department? Who is going to make underwriting decisions? Who is going to sell the cars? Who is going to collect the money?
The personnel structure of your department is very important. Some dealers choose to separate their departments by housing their BHPH staffs at a separate location, while other dealers leave everything under one roof. The one thing to remember is your personnel needs are affected by the amount of business you are looking to book.
Credit decisions need to be limited to one or two people. You can determine a financing matrix that you train all your people on, but the final decision needs to be made by upper management or ownership. From time to time there will be some exceptions, but it is important to limit those decisions to certain people. This needs to be determined up front in your business plan.
A salesman should be able to sell 12 to 15 cars a month, and a collector should be able to collect on 200 to 250 accounts a month. Once your portfolio is established, you’ll have a better grasp of how many collectors you will need based on the number of delinquent accounts. Usually a collector can adequately work 80 to 90 delinquent accounts per month.
Verifications are very important in your underwriting process, so you need to determine who will handle that duty. As your business grows, it will become a standalone position, but early on it can be handled by management or sales.
5. Defining Deal Structure, Inventory & Portfolio Management
Defining deal structure is another essential component of a BHPH business plan. Your customers will pay a premium for your vehicles because they need your financing help, but it is important to make it affordable for them while ensuring you can collect the paper. You also need to make the payments as convenient as possible. I always recommend setting up due dates on paydays.
Another important aspect of deal structure is the interest rate you charge. There are two separate schools of thought when it comes to setting rate. Use a lower rate and make it a marketing tool, or use a state max and give discounts to repeat customers or discounts for good payers.
Inventory must also be addressed in your business plan. Where will you get your vehicles? Who will recondition them? How much will you spend on reconditioning? You need to remember that most of your customers will pay for the car as long as it is running, so your inventory needs keep running for the life of your loan term.
A good BHPH business plan must also address cash management, portfolio management and accounting for losses. As mentioned earlier, when you run out of cash, you are out of business. It is important to watch cash collections versus beginning-of-the-month outstanding total due, beginning-of-the-month number of accounts outstanding, and contractual payments dues. These numbers should stay consistent over time, but by watching trends you can micromanage your business.
When it comes to managing your portfolio, you will need to look at a static pool analysis, which tracks groups of loans until liquidation and projects future losses. This analysis will also point out variations in underwriting and collection policies. There are several other portfolio management reports that can be used, but static pool analysis is the industry standard of portfolio value.
Lastly, you need to perform a loss analysis. I hate to be the bearer of bad news, but you’re going to have losses. Over time, you can work to minimize them by identifying trends in losses. When are they happening? Why are they happening? How much are your charge-offs? A study of these will all provide some valuable insight.
Writing a comprehensive business plan for your new BHPH venture can be very time consuming. It will also vary from dealer to dealer, but doing so will save you tremendously. Just ask dealers who have been in this business for awhile. Most have learned lessons by trial and error, so, if you don’t have to, don’t attend the school of hard knocks!
A good source for data to help you establish your operation’s deal structure policies is the National Association of Buy Here-Pay Here Dealers. NABD released the results of its annual survey in May. Here's a breakdown of some key benchmarks:
Average ACV per vehicle sold (including reconditioning): $5,284
Average CID per vehicle sold: $4,696
Average gross per vehicle sold: $4,239
Average amount financed per vehicle sold: $9,195
Average customer down payment: $1,185
Average weekly payment amount: $84
Average term in weeks: 129
Rob Hagen is the founder of SpecialFinanceCoach.com, a Houston-based consulting firm specializing in department setup and growth. He can be reached at [email protected].