Even consumers with an 820 credit score can expect interest rates of more than 7%, nearly double that of two years ago. - IMAGE: Pexels/Arina Krasnikova

Even consumers with an 820 credit score can expect interest rates of more than 7%, nearly double that of two years ago.

IMAGE: Pexels/Arina Krasnikova

Automotive retail consultant Max Zanan advises dealers to temper their expectations for 2024 as favorable conditions of easy money, low inventories and high demand come to an end.

“Dealers will need to wake up from their profit comas,” he says. “We are returning to the prepandemic way of doing business, where the finance department has to save the day;;because front-end grosses are evaporating.”

Higher interest rates and expensive vehicles are creating an affordability issue that will drive an industry slowdown, says Eric Fifield, chief revenue officer for EFG Companies, a provider of consumer protection products and services for the auto industry.

Nowadays, people can find the cars they need but can also expect to pay significantly higher interest rates. In fact, even those with an 820 credit score can expect interest rates of more than 7%, nearly double that of two years ago. That figure climbs into the double digits for borrowers in the subprime category.

The shift has had a spider-web effect across the industry, expanding from the center to touch everything from payments to financing and affordability, Fifield says.

“Consumers are paying hundreds of dollars more per month, even when they get their own financing. This has had a dramatic impact on vehicle affordability. Now you have more customers arranging their own financing or figuring out ways to pay cash, eroding dealership profitability. High interest rates are directly affecting profit margins and holding reserves, which directly impacts the options they can offer customers.

“All of this means, we will see a slowdown in demand, and as inventory bounces back, dividends will shrink.”

However, high interest rates also impact dealerships, which will pay more for their floor plans.

High interest rates raise dealer floor plan expenses, whereas low interest rates led to floor plan credits from manufacturers that generated up to $30,000 to $50,000 a month for large dealerships. Those credits are evaporating. “Now that same floorplan might cost the dealer $100,000 to $150,000 a month,” Zanan says.

It’s become very expensive for vehicles to sit on dealership lots. The focus on moving metal has made the finance-and-insurance department’s job harder, according to Zanan.

“The balance of power between buyers and dealers has shifted,” he says. In recent years, dealers could charge over manufacturer’s suggested retail price because of high demand and low inventory. The sales department raked in piles of cash, which sometimes made it harder for the F&I department to sell extended vehicle service contracts, Guaranteed Asset Protection coverage or ancillary products.

Now full lots, high interest rates and still-expensive cars may make sales more difficult, which makes profits more dependent on the F&I office.

“It’s time to get back to basics,” Fifield advises. “It’s not as easy to sell cars or F&I products anymore. F&I departments need to get back to basics. They need to focus on value proposition and less on holding margins on the front reserves or making profits by controlling financing. Maybe that’s a break-even or pass-through. They should worry more about offering coverages that match the consumer’s driving habits versus trying to make a margin on controlling finance.”

Hit the Books

F&I training sat by the wayside during the years of record profits during the pandemic, according to Zanan.

“Dealers were not even thinking about training because profits were falling from the sky,” he says. “Training in general, and F&I training in particular, has been neglected over the past few years. Dealers need to realize the more training they provide for the finance department, the higher probability that department will be able to save the day. But if they continue neglecting it, profitability for that department will be less.”

Fifield suggests dealers drive training to the forefront of their operations by making daily training meetings and weekly sales recaps a priority.

He says F&I managers should be well-versed in selling products and arranging financing that meets consumer needs. Dealers who work closely with their F&I partners can better train their staff and meet customer needs with customized product offerings.  

Remember Reinsurance

Reinsurance is another revenue stream, and it’s going to be even more important than it was before,” Zanan says. “There are many dealers who are not in reinsurance.” Even those dealers that are, may not reap the benefits of the programs if they don’t review them quarterly.

That is a grave concern if economic conditions worsen, Zanan says. “In the 2008 financial crisis, many dealers had to close their doors. But dealers with significant reinsurance portfolios were able to use that money to stabilize their operations. Now is the time to review reinsurance to understand what you are getting, how much you are paying in admin fees, and what kind of service you are receiving from a provider. Then make adjustments if necessary.”

Dealers that don’t do these things may be sorry later, he says.

Repair expenses are an area of concern that impacts reinsurance profits. The U.S. Department of Labor's September Consumer Price Index report showed a 17% increase in motor vehicle repair costs since 2022. The increasing expense of vehicle repairs is being influenced by lingering parts shortages and high labor costs.

“Now it takes longer for vehicles to get fixed,” Fifield says. “Most VSCs offer rental car benefits, and you’re going to see these things max out at a higher frequency than previously because parts are not drop-shipping as quickly. All of these things compound into a very different cost structure than the reinsurance positions are contemplating.”

Zanan explains with reinsurance, if a customer buys a VSC for $2,000, but only has a $500 claim over the term of the contract, the $1,500 remaining is underwriting profit that now belongs to the dealer. However, if parts and labor expenses are higher than when the contract was signed and a rental car is needed longer, that $500 repair may now be $1,500, take two months to complete, and cost the dealership another $1,000 in rental car costs. Now the dealer’s reinsurance profits are gone.

Rising vehicle costs and interest rates are causing consumers to keep their vehicles longer, adds Jennifer Rappaport, president and CEO of EFG Companies.

“When people keep their vehicles longer, they will have more issues with their vehicles as they age. This will increase the frequency and severity of claims, which has direct implications on dealers’ reinsurance claims. Cost per claim is something every administrator and every dealer is looking at very closely right now.”

Fifield says it’s vital that dealers take a deep dive into the analytics of what’s happening with their underwriting on a contract-level basis. “EFG reviews terms monthly and we adjust as we go,” he says. “We do that to make sure we are selling the right terms to customers. We want to match customers' driving habits to terms and coverage so that we dial in the loss costs on every single contract. You need to be proactive about changing the terms before losses get out of control.”

What’s Driving Delinquencies

Fitch Ratings' November data revealed 6% of subprime borrowers were at least 60 days past due on their car payments, the highest percentage since 1994. It attributed soaring late payments to the rapid rise in car prices and high interest rates.

As consumers' financial health declines, F&I managers must improve their financial skill sets, according to Zanan. “The real art of F&I is getting the deal approved.”

To ensure correct lender placement, Zanan advises confirming the finance manager's ability to read credit accurately. “Every bank is different,” he says. “Finance managers need to understand each lender's program and the credit criteria that is the lender’s sweet spot.”

To overcome deal challenges, Zanan recommends involving finance managers from the start. “A finance manager is more qualified to assess credit than a salesperson,” he says. “You don’t want to show a consumer a $55,000 vehicle, only to tell them later that they only qualify for a $35,000 car. You want to show the customer the vehicle they can realistically drive away with.”

Offer the Right Products

“The finance department is the glue that holds sales and service together,” Zanan says. “This means they need to sell products that bring customers back to the dealership.”

He recommends dealers consider adding retention-based products that encourage customers to return for service. Prepaid maintenance products, for example, encourage customers to bring their vehicles to the selling dealership for service.

Zanan says that when someone purchases a brand-new Honda, they may also buy a Honda maintenance plan for the next three years or 100,000 miles. With that plan, the customer can have their vehicle serviced at any Honda dealership. “There is no guarantee when you sell such a plan that the customer will come back to the dealership that sold them the car,” he says.

Instead, he says, the dealership could offer a dealer-owned maintenance plan that offers the same coverage but must be redeemed at their dealership.

“This helps the service department build a relationship with the customer so that as the vehicle ages and needs service for something that’s not covered by the plan, they will come to you. This product helps dealers make money down the road.”

Dealerships can work with their partners to establish VSC tiebacks that mandate customers living within 50 miles of the dealership return to the selling dealer for repairs. Other tiebacks may require repairs priced over a certain dollar amount to be performed by the selling dealership.

“That keeps your technicians busy because customers are coming back,” he says. “And it allows you to keep building that relationship by providing excellent service.”

Another benefit of keeping the service bays full is that it positions the dealership to weather an economic downturn, Zanan says.

“A downturn means a decrease in sales. How can you make up for that lost revenue to keep the doors open? In a downturn, the service department is going to save the day. The more retention-based F&I products you sell, the busier your service department will be.”

When faced with an unknown journey, drivers rely on a good road map to reach their destination. The experts say a road map for F&I sales is a solid plan for the year ahead. For 2024, Zanan says a plan that includes F&I training, reinsurance program audits, and customized finance products will ready dealers for that journey.


Ronnie Wendt is an editor at F&I and Showroom.


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