The ultimate goal of BHPH lending is to align the sale, the loan, and collections to optimize profitability. A very wise and successful BHPH dealer operator shared his strategy for success: Get the customer to the Trade Zone (12 to 18 months) with a grand in their hand, and everyone is happy. Truly sage advice, but how do you do that?
Gross margin drives Loan To Value (LTV), which influences Payment To Income (PTI), which influences Term. All of which influence getting your customer to the Trade Zone.
In my past life managing auto finance companies, the primary drivers of loss were PTI (frequency, how many go bad) and LTV (severity, how much you lose). Managing PTI is relatively simple: 18% or more is the Death Zone. LTV, especially as a dealer operator, is more a function of managing greed and fear. If you get too greedy, you will have to manage your fear (losses).
Guidelines for managing greed and fear:
- You only make a gross profit from payments made, not when you repossess.
- You only earn interest if payments are made.
- 20% of losses happen by month 6, 50% by month 12 and 75% by month 18.
- The unit will not be in better condition after repossession.
- PTI and gross drive term, and you know what the PTI must be.
- A good unit will make it to the Trade Zone, but a weak one won’t (and it won’t the next time around).
The gross you want to achieve (after you have adjusted for any value lost during the loan lifecycle), has to be realized by payments received by month 12. Any payments a customer makes beyond that are gravy. Besides, your customer is ready-made to trade.
There are the “Unicorn” situations where the customer paid to a 48-month term, but those are few and far between. Getting a loan to the Trade Zone is the ultimate goal, so managing your gross is the key.
Our mission at Agora is to maximize the value of BHPH loans and the dealerships who make those loans. It is hard work to sell a car, finance the car, and collect the loan. Sometimes dealers inadvertently 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 BHPH success: How is it defined, measured, and accomplished.