I have had the honor and pleasure to be a part of the subprime finance industry for better than 20 years now, and I can assure you this is the weirdest year I can ever remember. Now, the industry has always been a little atypical and I wouldn’t consider it cyclical by any stretch, but there always seems to be a flow to it. Not so much this year.
The one thing that has been normal this year is that this seems to be the time of year that dealers revisit their underwriting guidelines. Dealers who may be a little behind (as far as their volume projections) loosen up. Those who have the good fortune of being ahead of their projections tend to start looking at ways to tighten up.
Whether you are looking to loosen or tighten up, overall consistency in your underwriting is the key to a well-performing portfolio. To help ensure that consistency, there are four areas you should focus on. I learned them as the SAWS of underwriting, which stands for:
Stability is first and is the most important when it comes to the buy here pay here customer base. Obviously, this refers to how stable the customer is. This will include the time at residence and time at job. Through surveys and analysis we do as part of our 20 groups, we have found that the BHPH customer averages two to three years at their residences and jobs. This means that the average customer will change both residence and job at least once in the term of their note. So make sure the history you get from a customer goes back for a period of time equal to or greater than the term of the loan.
Ability is the next focus area and is closely tied to stability. Ability can also be called affordability. This is what the customer can afford, or their ability financially to make their payment. We have found when customers’ vehicle payments are kept at or below 25 percent of their net income, those deals tend to perform better. The key here is to figure payments based on net income, or bill-paying income. Ask the mortgage industry how that whole payment-as-a-percent-of-gross-income concept worked out. The biggest underwriting mistakes made are in this area, and usually with repeat customers.
Willingness is the third focus area. This does not necessarily refer to the customer’s status according to their credit report. This refers more to, for example, how they pay their rent and their rent-to-own accounts. We expect to see less-than-satisfactory pay histories on their credit reports, but hopefully they are paying their landlord and the furniture payments fairly well. If they are slow in those areas, there’s a good chance they will be slow to pay you as well. The credit report should be used more for verification of what the customer has told you more than an actual decision-making tool.
Security is the last focus area. This refers to the overall deal structure. Down payment, term and exposure are all factors here. Also, the type of vehicle, mileage or intended use should be considered as well. It is listed last because if the first three areas are in line, this area has more room for negotiation. If the customer is stable from a residence and job standpoint, earns a decent wage, and is not a credit criminal, then you have some maneuvering room here. Maybe you can accept a little less down or stretch the term a tad.
All four of these areas should be taken into consideration before you approve a deal. All four should make sense for not only you and your company’s business model, but also for the customer. You can sell as many vehicles as you want in this business. It just depends on your appetite, or lack thereof, for risk.
Loosening up on underwriting can increase volume and, if managed properly, increase profitability. It can also, if mismanaged, sell you right out of business. Tightening up on underwriting can reduce exposure and increase cash flow long-term if managed properly. It can also, if mismanaged, choke the life right out of your business.
So is it time for you to loosen or tighten up underwriting? Guess it all depends on how hungry you are.
Vol. 8, Issue 9