Offering auto financing can increase a dealership’s sales and profitability. For many customers, the ability to finance a vehicle at the point of purchase is a deciding factor. Integrating financing into your business model serves a wider customer base and creates additional revenue streams. This guide explores the methods and requirements for setting up an auto financing program.
Understanding the Financing Models
A dealership can facilitate vehicle financing in a few primary ways. The most common method is indirect lending, where the dealership acts as an intermediary. The finance and insurance (F&I) department collects a customer’s credit application and submits it to a network of third-party lenders, such as banks, credit unions, and finance companies. The lender approves the loan and funds the deal, while the dealership handles the paperwork.
Another approach is in-house financing, often known as Buy Here Pay Here (BHPH). With this model, the dealership itself acts as the lender, using its own capital to finance the vehicle purchase. Customers make their payments directly to the dealership over the term of the loan. This method gives the dealer complete control over the financing process, from approval to collections.
It is also useful to understand direct lending. This occurs when a customer secures their own financing from a bank or credit union before they visit the dealership. In this scenario, the customer arrives with a pre-approval or a check from their lender, effectively acting as a cash buyer. The dealership’s role in the financing process is minimal in these transactions.
Setting Up Indirect Lending
Establishing an indirect lending program begins with building a network of lending partners. This involves reaching out to national banks, local credit unions, and specialized subprime lenders. Lenders will want to see that a dealership has been in business for a stable period, has a solid sales volume, and maintains a good reputation. They will review the dealership’s financial statements and business plan to assess its viability as a partner.
To streamline sending credit applications to multiple lenders, most dealerships use a lending portal. The two dominant platforms are Dealertrack and RouteOne. These web-based systems allow an F&I manager to submit a single application for review by numerous lenders simultaneously, increasing the chances of securing an approval. Integrating with these portals is a standard step for offering competitive indirect financing.
When approaching potential lending partners, it is important to understand their specific underwriting criteria. Some lenders focus on customers with prime credit, while others specialize in the subprime market. A good strategy involves partnering with a diverse range of lenders to serve the widest possible spectrum of customer credit profiles. Clear communication and an understanding of each lender’s programs are necessary for a mutually beneficial relationship.
Exploring In-House Financing
Opting for in-house financing, or the Buy Here Pay Here (BHPH) model, changes the dealership’s role from a retailer to a finance company. This path requires a significant amount of capital, as the dealership is using its own funds to originate loans. Unlike indirect lending, where a third-party lender provides the capital, a BHPH dealer assumes all the financial risk associated with the loans.
A BHPH operation requires a robust collections department. Since these dealerships often work with customers who have poor or limited credit histories, the risk of default is higher. The collections team is responsible for managing customer payments, handling delinquencies, and, if necessary, initiating repossessions. This requires dedicated staff with training in collections practices and customer service.
To mitigate risks, BHPH dealers employ specific tools and strategies. It is common practice to install GPS tracking devices on financed vehicles, which aids in vehicle recovery in the event of a default. Payment reminder systems are also used to help customers stay on track with their payments. The success of this model hinges on careful underwriting, diligent collections, and effective risk management.
Navigating Legal and Compliance Requirements
Offering auto financing subjects a dealership to federal and state regulations, regardless of the financing model. The Truth in Lending Act (TILA) mandates clear disclosure of credit terms. This includes providing the customer with the Annual Percentage Rate (APR), the finance charge, and the total of payments in a standardized format before they sign the contract.
The Equal Credit Opportunity Act (ECOA) is another federal law that prohibits discrimination in any aspect of a credit transaction. This means dealerships cannot make lending decisions based on race, color, religion, national origin, sex, marital status, or age. All applicants must be evaluated on their creditworthiness. If credit is denied, the dealership must provide the applicant with a specific reason.
The Fair Credit Reporting Act (FCRA) governs how dealerships can access and use a consumer’s credit report. Dealerships must have a permissible purpose, such as a credit application initiated by the customer, before pulling their credit information. Beyond these federal laws, dealerships must also comply with state-specific licensing requirements for auto sales and financing. Consulting with legal counsel specializing in automotive law is a recommended practice.
The Customer Application and Deal Structuring Process
A dealership’s financing activities occur in the Finance & Insurance (F&I) office. The process begins when a customer applies for financing. The F&I manager collects the necessary personal and financial information, including proof of income and residency. The manager then has the customer sign a credit application, which provides consent to pull their credit report.
With the customer’s information and credit report, the F&I manager proceeds to structure the deal. In an indirect lending model, the application is submitted to the dealership’s network of lenders. The lenders will respond with their decisions, which may include a specific approval, a conditional approval requiring more information, or a denial.
Once approvals are received, the F&I manager can finalize the deal structure. This involves negotiating the interest rate (APR), the loan term, and the required down payment. The goal is to find a combination of terms that the lender will approve and the customer finds affordable, while also allowing the dealership to meet its profitability targets. The F&I manager presents these final terms to the customer for their agreement before completing the sales and loan documents.
Profiting from Auto Financing
A dealership’s Finance & Insurance (F&I) department is a profit center. In the indirect lending model, a primary way a dealership earns revenue is through “dealer reserve” or “spread.” This is the difference between the interest rate the lender offers the dealership (the “buy rate”) and the final interest rate the customer agrees to (the “sell rate”). Lenders allow dealers to mark up the buy rate, and the dealership retains this difference as compensation for originating the loan.
Beyond dealer reserve, the F&I office generates profit from the sale of backend products. These are optional products and services offered to the customer with the vehicle financing. The sale of these items can increase the overall profitability of each vehicle sold. Common F&I products include:
- Guaranteed Asset Protection (GAP) insurance, which covers the difference between the loan balance and the vehicle’s value if it’s totaled.
- Extended warranties, also known as vehicle service contracts, which cover the cost of certain repairs after the manufacturer’s warranty expires.
- Tire and wheel protection.
- Prepaid maintenance plans.
- Credit life insurance.