Posted on Nov 28, 2016

At the 2016 NIADA Convention, discussion of deep subprime competition on Wall Street emphasized that the model is not sustainable. But the question is not “when will the competition go away?” The question is “how can BHPH dealers compete now?”

Studies of the auto industry have shown that the average used car loan term is upwards of 63 months (5.25 years) with average monthly payments of $359. In essence, the deep subprime industry is extending the term, accepting a lower down payment and a lower monthly payment on average to increase volume.

However, successful independent BHPH dealers are limiting terms to 15-42 months, asking for at least $1,000 down and $12 more a month on average (amazing, but true).

This business model is cash focused rather than loss focused. Successful dealers limit their cash outlay for vehicles and set up transactions to recover their cash as quickly as possible. This is done by limiting their ACV to $5,000 and not more than $7,000. Also, while industry averages for customer down payments have slipped below $800, successful dealers are maintaining average down payments around $1,000.

Remember that the competitive landscape is increasing your risk. Your customers accept the benefit of lower-priced cars by putting some skin in the game with a higher down payment and higher weekly or biweekly payments. The National Bureau of Economic Research estimates that – all things being equal — extending a given buyer an extra $1,000 in credit correlates to an increased risk of default rate by 15 percent. Consider a customer putting $1,000 down on a $5,000 vehicle. The customer already has 20 percent equity in the deal, which has been shown to motivate more customers to make payments and not lose their initial investment. In turn, the BHPH dealership is receiving more cash up front.

A study for DriveTime noted that charging 20 percent APR is a fair return for risk in the current deep subprime market. Depending on caps in your state, reasonable APR can be as high as 23 percent, which puts your monthly interest payments at just under 2 percent.

Be aware that simple interest is a better method of accounting for BHPH dealers than accrued interest. The customer’s next interest payment is based on the previous month’s balance and doesn’t matter whether the customer makes a payment on the first day or last day of the billing cycle. Simple interest is a fairer process for dealers, especially with the variety of payment options offered to customers.

Now, if your salespeople are focused more on commissions than on securing a high average down payment, you may not be achieving the highest possible down payment available. Calculate the average down payments in your portfolio. Are the down payments fairly similar from one transaction to another? If so, then you may have a sales process problem. You will need to observe how salespeople are handling deals to make sure they are asking for higher down payments relative to the total sale price.

Cash Flow is Still King

As we have written about before, a healthy BHPH dealership has financial flexibility. That occurs through careful management of cash flow. With financial flexibility, your dealership can seize on opportunities that range from inventory purchases to upgrades in the service department and more sales or office staffing.

Cash flow can be improved by restructuring your business model and ensuring that transactions in your portfolio are achieving higher down payments and healthy margins. Old contracts should be replaced at a healthy rate while keeping customers in their vehicles as long as possible.

We also observe that dealers who control warranties and flexible service contracts also have stronger ongoing cash flow. These income streams make BHPH dealers more competitive as they encounter more of the “least-able-to-pay” customers in the market.

Some BHPH dealers are also exploring Lease Here Pay Here programs. This is not for every dealer. First of all, because the car title remains in the dealership’s name under a lease agreement, the dealership could be held vicariously liable in some states if the customer has an accident. Dealers need to carry “contingent” or “excess” liability insurance to mitigate the additional risk.

Monthly payments are smaller compared to financing, however dealerships can defer taxes because they can depreciate their inventory. Sales tax expense is typically reduced because it is remitted gradually over the course of the lease with each lease payment.

The residual value of the car at the end of the lease can make it easier to sell the car because the customer gets more car for a lower monthly payment. Most of the time, the customer will opt to extend the lease on the same car or lease a different car. If the customer opts to return the car at the end of the lease, this supports inventory at a time when finding vehicles at lower price points is difficult.

Another alternative source of cash flow is to sell part of the dealership’s entire credit portfolio. Although the credit portfolio is a dealer’s best asset, not every dealer has the skills or interest to manage it well. Certain financial services companies are offering programs to purchase all or part of the portfolio in exchange for up front cash — lowering long-term risk and eliminating any service or collections issues. The down side to this option is less control over the customer relationship and potentially less flexibility in deal structuring.

Continue Reading: Traditional BHPH Income Opportunities

Cornwell Jackson works with BHPH dealers frequently to adopt new approaches to service, cash flow and profitability. Review our previous whitepapers for your industry or contact us for a consultation. We can even assist with audits, reviews and compilations specific to dealerships to help your dealership access traditional bank financing or working capital if needed. We can also consult on timing and requirements to establish a related finance company as part of BHPH auto financing and portfolio management.

Scott Bates, CPA, is a partner in the audit practice and leads Cornwell Jackson’s Business Services Department, which includes a dedicated team for outsourced accounting, bookkeeping and payroll services. He provides consulting to clients in auto, healthcare, real estate, transportation, technology, service, retail and manufacturing and distribution. Contact Scott at or 972-202-8000.