Used Car Finance Lessons
By Steve Gillman
You might think that used car financing simply involves a
dealer, a bank or other lender, and a down payment on the part
of the buyer. That is how it works in some cases, but it gets
much more creative than that. Let's look at a real life example,
and see what lessons can be learned to apply to making money
in other businesses.
A friend of mine used to have a used car lot. He teamed up
with a creative used car finance company to sell cars to people
who had trouble getting traditional loans. I don't recall the
name of the company, and I may get a few figures wrong, but I
remember the principles very clearly.
A typical deal might have started with a trip to the dealer's
auction. This dealer would buy a car there for $1,200 (wholesale)
which might have had a retail value of about $2,200. But because
he is making it easy for somebody to buy the car, he can sell
it for perhaps $3,000 after cleaning it up.
How does he make it easy to sell at a high price? By arranging
financing for the buyer, who typically cannot get a bank loan.
How does he do that? With a very creative finance company that
rarely refuses to make a loan.
How can they make loans to people who are a terrible credit
risk? By putting much of the risk onto the dealer and charging
outrageous interest rates. Specifically, in this case, they would
finance the $3,000 car at say 20% annual interest. But they also
would only forward half of the loan amount to the dealer. The
rest would be paid only when and if the payments from the buyer
In this example, then, the buyer might have to pay an $600
down payment. A young couple can put together a couple paychecks
to afford this. Payments on the $2,400 loan arranged by the dealer
might be $200 per month. As I recall, weekly payment plans might
have been available as well, to make budgeting easier for those
with weekly or bi-weekly paychecks.
The loan would be for $2,400, but the dealer would get $1,200
when the sale was made - half of the loan amount. As you can
see, the dealer is already okay, since he has received a total
of $1,800 for a car that cost him $1,200. In other words, if
he receives nothing more he may be able to squeeze a profit from
these deals even after overhead costs.
What about the used car finance company? So far they have
only risked $1,200, on a car which is worth that much at a wholesale
auction. They collect 20% interest on the entire $2,400 however,
as well as some kind of "loan processing fee" up front.
This makes their real rate of return over 40% annually.
Of course, these are high-risk loans. I heard through the
grape vine that 50% of these loans were in default at some point.
But the finance company had an aggressive collection team, which
called borrowers as soon as they were a week late, and quickly
repossessed cars when necessary.
What does that mean? As an example, suppose a buyer ran into
trouble and stopped paying after the first eight payments of
$200. The principle amounts had been forwarded to the dealer,
but the lender would have already collected about $400 in interest
and fees. When they took the car and sold it for $1,100, they
might net $800 after the repossession fee and other costs. In
other words, they broke even on the deal. When you make a 40%
return on the good deals, you can break even on a lot of the
Used Car Finance Lessons
One dealer who had used this finance company was still receiving
checks for principle years after he retired, so he liked the
arrangement. Despite the high interest, the buyers who now had
a car to get to work in like the deal, or at least found it better
than all other options. The owners of the used car finance company
were happy making money where nobody else dared to loan. It was
very creative all around, so what specific lesson can we learn
to apply when making money in other businesses? Here are three:
1. High mark-up products allow for more creativity in marketing
2. Making it easy to buy allows you to charge more for your
product (or service).
3. Finding a way for everyone involved to "win"
helps you make money.
There are other lessons in the this story of used car financing,
of course. For example, in the case of the lender you can see
that going where others fear to go opens up new opportunities.
Sharing the risk is also a useful way to make things possible
that otherwise might not be. Of course, the buyers out there
might see the lesson that you pay a lot more when you finance
things, and especially when you have bad credit.
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