One of the great things about the BHPH industry is the power it gives you to make all the credit and underwriting decisions. But, as wise old Uncle Ben told Peter Parker (aka Spider-Man), “With great power comes great responsibility.”
After a long career of running subprime auto finance companies, I learned to understand its critical risk drivers. Uncle Ben’s wise words apply to our industry when it comes to the responsibility of sound loan payment underwriting.
If your Payment to Income Ratio exceeds 18%, the default odds will be excessive.
That doesn’t necessarily mean the loan cannot or will not perform. It means the odds of default are now not in your favor. I am not suggesting you should immediately implement radical changes to your underwriting; instead, I recommend you review your past and current loans, assess the PTI, and see if a trend becomes apparent.
PTI is a simple calculation: The payment divided by the gross monthly household income of the customer. If the customer’s income is $3,000, a monthly payment of $360 gives us a 12% PTI. The PTI and payment amount falls well within the safe zone. The same customer with a $540 payment at an 18% or more PTI? Yikes!
In my time at AmeriCredit, Chase, and ACA, every analysis found that one of the top predictors of risk was PTI. Different organizations—common strategies. As you get closer to 18%, your loss odds dramatically increase, so keep a close watch on PTI when it gets higher than 15%.
IMPORTANT: The payment is a fixed number, and so must be the income! You must ensure that the gross monthly household income isn’t “stated.” Ensure that it is substantiated with a paystub or affirmatively verified. The analytics that drove this underwriting strategy was based on verifiable income.
Our mission at Agora is to maximize the value of BHPH loans and the dealerships who make those loans. There is a lot of hard work involved in selling and financing a vehicle and collecting the loan. Sometimes, we unintentionally make it harder than it has to be. That is why we will continue to share these little “nuggets” as an ongoing series.
Stay tuned: Our next edition will discuss the 2nd most critical risk driver of BHPH loans and how it impacts repeat and referral business.