OK, there is apparently a LOT of misinformation floating around on how to calculate a loan. The most common misconception is to take $ 10,000 and multiply it by 18% to get Interest of $ 1,800. But this is highly incorrect.
The words Interest and Finance Charges are used interchangeably by most people in the financial industry.
The standard Loan Calculation goes like this:
The reason why it isn’t as simple as Principal x APR is that a Loan is Amortized over a period of time, and paid in regular installments, meaning that the original Principal isn’t loaned out for the entire time, it is paid back gradually. Since the lender collects some of the Principal with each payment, the interest declines to reflect only the amount of interest due on the current Principal Balance. The formula above is the best way to achieve a payment that reflects a Declining Interest Amortization payment.
The following image is the Estimated Amortization for this loan. Note how the interest on each payment Declines to reflect the interest owed for the Principal Balance for that payment date.
The above Estimated Payment Schedule uses a standardized 30 days for each period to arrive at the Interest Due for a payment. The reality is, that if you pay on the exact due dates, then the days passed between payment dates is not 30 each time. In fact, of these 36 payments, only 12 are 30 day periods, and 21 are 31 day periods. There are 2 periods of 28, and 1 of 29 days.
Since the rules allow the lender to calculate the interest using the exact days, the interest being paid will vary on 24 of the 36 payments, 21 of them being higher than estimated. The calculation for the interest due for any given payment is: Principal x (APR/ DIY) = Interest per day. IPD x Days = Interest Due. “Days” refers to the number of days since the last payment.
Let’s look at the Estimate again, this time with Actual Days being used on the right side to show the payment breakdowns.
Adding the Interest from the Actual Days together, the consumer will pay $3,077.74 , not the Estimated $3014.72. And, due to paying 63.02 extra in Interest, there is now 63.02 Principal left owing after the last payment.
Keep in mind, too, that when the consumer pays on a date that is not on this schedule, the amount of Interest Due changes to that payment date, and that can change the rest of the schedule. For example, let’s say this customer pays the first payment 10 days late. The Interest Per Day is 5.00 at that point, so the Interest Due becomes 200.00 instead of 150.00. Paying just the normal payment amount allocates that amount to Interest, and the principal allocation drops by 50.00, since Principal Allocation is simply Amount Paid – Interest Due.
Since the Principal balance is higher that the original estimate for Payment # 2, the interest due rises, so the allocation to principal for payment 2 is lower, making the principal balance for Payment #3 higher than expected.
That 50.00 extra interest on payment #1 costs the consumer 52.65 total over the life of the loan, even if the rest of the payments are made on time. This person now has a final principal owed of $65.67 instead of $63.02.
I hope this clears up the questions about the Interest Calculations. If not, drop a comment, and I’ll be glad to see if I can help.
In many areas of the US, we are subject to devastating storms or other natural disasters like wild fires, earthquakes, and other things.
My question to you today as an Owner or Manager of a used car lot (or other small business) is: Are You Ready For It?
What that means is that since these disasters can usually render your entire business to a pile of ash or rubble, what will you do The Day After?
It’s important to have a Disaster Recovery Plan. This plan consists of a WRITTEN set of action that you and your employees will take when that disaster is imminent. Some things to have on this plan are:
Backups of computers that contain important data or images of documents.
These backups need to be on removable devices that can be taken away from the location. I also recommend that you have multiple backups, and those backups stored in different off-site locations.
Online backups with reputable companies can be your second backup, but should not be your primary, since at times, your access to the Internet may be limited or unavailable for several days. Some examples are:
There are many others. Yes, there are costs associated, and you need to review how large a single backup set is, and get 25 times that size. Compare services to get the best deal for what you need.
The better plans include an app installed on the computers that automatically backs up selected folders. Set it, implement it, then verify it after a backup to make sure you are getting everything needed. Review this backup monthly to ensure you continue to have the backups that are crucial.
Whichever one you use, it MUST be secured with a strong password, and access should be limited to only key management employees.
Printed reports detailing Inventory, Accounts Receivable and Payables, Revenue, and Payroll.
Yes, PRINTED. On paper, and then secured in a safe at home or other offsite secured location. You can also create PDF files of the printed reports, if your software allows, and store those on your backup devices or online storage. But the printed version may be necessary if your power is out and access to the internet is limited.
If your software does not have a “Save to PDF” option on the reports, then set the Printer to one of the “Print to PDF” printers that are in almost every computer’s printer list. Selecting Print on these prompts you to name the file and define where the file is to be stored.
Print these out regularly, like on the first day of each month, and make a new print before leaving in front of the storm or other approaching disaster.
When preparing for an incoming storm or other destructive force, one of the last things to do is to quickly take an inventory of the units on hand for sale, and other items such as computers or other office machines, shop equipment, tools, and note any customer cars on site. Consider taking primary computers and printers with you out of the path of the destruction. Encourage employees to take expensive tools or personal items home.
Secured Storage for irreplaceable or hard-to-replace documents.
The laws typically allow that a scanned image of a signed document such as a Finance Contract or Bill of Sale is an acceptable replacement for an original. Always have scanned images of:
Sales documents, including customer verification items, after a sale is complete.
Official notifications such as Bankruptcy Notifications, Federal or State Regulatory notifications/letters, and letters from attorneys.
These are mush easier to find on a computer than sifting through file cabinets anyway. Organize the files into folders that group similar items. Name the PDF or image with a name that indicates what it is, to whom it pertains, and the date of the file. For example, the sale documents should have a name like: SALEDOCS_CASH_ACCT4156_SMITH_JON_2020.10.10.PDF SALEDOCS_BHPH_ACCT5055_REED_AMY_2020.05.06.PDF SALEDOCS_BANKFIN_ACCT5144_BENSON_GILLUAME_2020.10.12.PDF
The current BHPH accounts will be in a folder called SALESBHPHCURRENT and the former accounts or Cash deals will be in a folder called SALESPAIDOUT.
But things like Car Titles, Deeds, Business Licenses, Tax Certificates, and other official papers must (usually) have the original form. Have a plan to either get duplicates (when legal to have them) or to secure the ones on site. Don’t assume which is which! Get some qualified advice!
If you take such things home or to another off-site location, use a fire- and water-proof safe to store them in. It’s also a good idea to have that inside the business as well.
Take photographs of the business before leaving.
Simple to do with a smart phone, just walk around take some pictures of the building inside and out, wide view shots of the inventory, any customer cars that will remain, and shop equipment.
As soon as you can get back on site, take the same photos again, especially if the items are damaged. These will go a LONG way towards establishing insurance or disaster relief claims.
CHECK YOUR INSURANCE COVERAGE!
This part is crucial. Many businesses lose a lot after a disaster due to lack of insurance coverage for certain situations.
I talked to a used car dealer once who did not disclose to his long-time insurance company that he had added a small shop to the business, and after a fire, the insurance company would not cover the building addition or the shop equipment.
In hurricane areas, your insurance typically does not cover flooding, and the insurance companies consider storm surge to be “flooding.” Make sure you have flood coverage if you are within a certain distance of the coastal areas, or within the “flood plain” of a river.
If you need to, name a person to be responsible for the plan, and give them the authority to implement it.
Finally, once the plan is put in effect, review it at least annually, and revise it as needed.
Thanks for visiting and reading. Remember, useful and clean comments are always welcome, as well as requests for a topic.
Thats a quote I find myself using a lot in my line of work advising used car dealers. The reasons I say it range from the mundane to the shocking.
First, and foremost: I am NOT a Lawyer. I do not pretend to be one, and frankly, not sure I’d want to be one. (No offense, Counselor, but I’m just not the type.) I do read extensively and research a lot, which leads me to a lot of legal decisions. My telling you ar anyone else what I have read or what my experience is does NOT constitute “legal advice,” and I always make it a practice to remind listeners/readers of this. Don’t misinterpret anyone’s advice for qualified legal advice, if it refers to a situation that may involve a law or legal situation.
The latest opportunity for me to lay the “Talk to your Lawyer” on a dealer stemmed from a request to add a “binding agreement” that the customer signs that says that the customer agrees NOT to add the car loan to bankruptcy proceedings if they file. Bankruptcy rules do not permit such agreements, and in fact, the laws specifically say they are not permitted. In some situations, you can ask the consumer to reaffirm the debt or to waive discharge at the time of the bankruptcy proceedings.
I’ve had dealers call me and want to read me a summons or subpoena they have gotten, and they say, “Will you tell me what to do?” I say yes, gladly. Take your phone and find the number of your attorney, dial it, and ask them to meet with you. That’s my advice. I’ve gotten that call one day and the dealer was whispering. I asked him to speak up, he said he couldn’t, he was in the hallway outside the courtroom. He was literally about to walk into a courtroom to answer this subpoena, and wanted advice on handling it and what to say. I stopped him before he could read me the details of the case. I asked him to find any attorney walking that hall and offer them a fee to just go in there and ask for a continuance. He gets mad at me, and asks why won’t I help him.
Another instance I get a lot is a request to have an “agreement” signed saying the customer cannot take the BHPH car out of the state (or county!) at any time for any reason. I read some years ago a scathing decision by a judge excoriating a dealer who had such an agreement, and when the customer went over the state line to visit relatives, the dealer repossessed the car the moment the customer returned home even though the customer was paid ahead. A short version of the judge’s commentary was basically that the dealer, as a lien holder, could NOT control the movements of his customers. Adding to the judge’s ire was that he discovered that the dealer had been using a GPS device to track his customers, and had put in a “geo-fence” notification to alert them when the customer crossed a state line. Also, the dealer charged the customer an EIGHT HUNDRED DOLLAR “repo fee” even though all he did was send a guy over to the person’s house with a spare set of keys to drive it back.
Side Note: If you are using GPS devices like that guy to track the movement of customers who are not in arrears, please stop. It’s called Stalking.
In a similar vein, I get asked periodically to add a clause to the finance contract that moving out of state is grounds for repossession. Again, judges have said that you cannot control where your customer lives, and you cannot even require them to get “prior approval.”
Also on the “Ask Your Attorney” list is the “How much can I charge as a Repo Fee, and under what circumstances can I repossess the car? ” Short version from me is that the contract allows repossession if the consumer breaks the contract. That may mean being late on a payment, failing to have insurance, or other clauses. How late is late? Good question! Please comment on this post if you can find someone to officially put that value in writing. In my nearly 30 years in and around this industry, I have never seen that defined. How much repo fee? I have heard a judge say that the dealer can “recover expenses related to the repossession.” So, your flat $500 fee won’t hold up, especially if you can’t demonstrate but around $75-$100 of it.
One of the most frustrating is when I advise someone that in my experience, this thing is not allowed, but, again, ASK YOUR ATTORNEY, and the caller will say: “But Fred down the street has been doing this for 20 years, and he’s never been sued or fined over it.” My clarification: 1. Fred has never been caught at it. and therefore, 2. Getting away with something doesn’t make it legal.
“But that’s an outrageous law!” — OK. And sometimes, I agree. But I can’t give you permission to break it, nor, for that matter, can your attorney. But the attorney can at least agree to represent you for breaking it. No, I can’t give you a “workaround” for it, because you could still be found to have violated the law, and now, I’m an accessory to the act.
You want to argue about a law, fine. Some days, I even have time to listen and commiserate with you. But be sure to get your legislator on 3-way for the call, too, because that is where your complaint needs to start.
Ask your attorney, because Fred and I can’t give you legal advice. Fred’s actions and his dumb luck aren’t legal advice.
Talk to your lawyer. That’s why you pay them, that is what they train for, and mostly, because when it goes wrong, they are the ones have to help you clean up the mess.
Thanks for the visit, tune in next time, when, hopefully, by then I will have a new topic to discuss.
The current Covid19 / CoronaVirus situation has changed a lot of how we do business. With the recommendations against in-person meetings or personal contact, it’s time to re-think the business model, at least temporarily.
First and foremost, do not allow your employees to spread rumors or scare stories. Manage the messaging. Only present what is coming from the official scientific channels. Regardless of how you feel about certain political figures, please realize that they have proven themselves to be dangerously uninformed, and some have been found to be outright lying. Trust the medical professionals and scientists.
Understand that people are scared of the possibility of getting either very sick or even dying from the disease. This is going to affect how they interact with others. Anxieties are heightened, and you should respect that. This includes employees and customers. People are going to be hesitant about coming in to the dealership to pay their payments, so you have to come up with incentives. If you do not take credit card payments, then now is the time. At least during the current state of emergency, do not attempt to collect “convenience fees.” Accept the 3% or so fees for the cards as your part of helping people out.
People who are out of work and are not earning pay will be late or struggle to make any payments. Be willing to waive late fees for a while, and forego repossessions at this time. Work with people.
If your collections or accounting people have a good internet service, consider allowing them to work from home. Remember that with so many of the school systems closed, there are a lot of people with kids at home who are also being expected to provide at-home instruction that the school has sent home.
If you have an employee who exhibits symptoms, be on the safe side, and send them home! You owe it to the other employees to provide a safe working environment. It is generally allowed to request an employee get tested, if the testing is available, but if they decline, just ask them to remain away from the dealership.
If an employee does test positive, and shares this information with you, analyze who was in close contact with them, and proactively send those employees away from the location.
Do not name or shame any employee! Be discreet. It is your place as owner or manager to also curtail any attempted bullying or abuse of employees by their co-workers over suspected illness.
Next, CLEAN the dealership, especially if there are suspected symptoms. Provide sanitizing wipes or materials to the employees who are on site and request that they clean their workspace daily. Consider paying a local cleaning company to deep clean the office.
Last, place a large sign on your door requesting that any customer who is sick or who has been around sick people to please remain away from the dealership. Put a phone number and email address on the sign to allow customers to contact you. Put a note to this effect on your website, Facebook page, or other social media interaction sites.
There are new laws concerning paid leave in these times, and you should contact an attorney who will advise you on them. If you do not have an attorney, you should contact The Gregory Law Group. This firm has experience with used car dealers and the industry, and has done some tremendous research on these new rules.
Does Ms Hagan think that the banks are NOT earning money off of Simple Interest? Surely she can’t think we are that stupid. Has no bank EVER lined it’s pockets by collecting Simple Interest?
Debt.org has a column called “The Rule of 78 – How To Avoid a Debt Trap.”
Short answer is, NO, it is not. A brief explainer:
Example Loan: 15000 Financed for 48 Months @ 9.25 % APR. Payment=375.06/month, Total Finance Charges= 3002.88
Rule of 78’s uses a formula to allocate the Finance Charges (Aka Interest) on each payment that does not use the number of days, it uses the payment number. Also called “Pre-computed,” because the Finance Charges are pre-computed for each payment. The formula uses the inverse payment number over the “Sum of the Digits” as a fraction multiplied by the Total Finance Charges to arrive at the Finance Charges due for this payment.
Using the above Loan Example, 48 Months: The "Sum of the Digits" has a value of (1+2+3+4....+48) = 1176. If you are on the first month, then the fraction is: 48/1176 = .040816 3002.88 x .040816 = 122.56 Finance Charges due for first payment. (See Amortization Comparison below.)
By contrast, Simple Interest uses a formula that takes the APR/Days in Year to arrive at the Daily Rate. This rate is multiplied by the current Principal Balance to arrive at the Daily Finance Charges. That value is then multiplied by the number of days since the last payment or Loan Date to get the Accrued Finance Charges. Another version uses APR/Periods to arrive at a Periodic Rate. So, instead of APR/360 x Principal x 30 days, you’d simply have APR/12 x Principal to get one Month of Finance Charges.
Again using the Loan Example: APR/Days in Year: 0925/360=.0002569444 = Daily Rate .0002569444 x Principal 15000 = 3.854166 Daily Finance Charges. Then, 3.854166 Daily x 30 days = 115.62 Accrued Finance Charges for the first payment. Noted, some Financial Institutions use 365 Days instead of 360. Also note that this is the Standard Amortization. When the payment is paid, the Lender will typically use the Actual Days, So it will matter if the First Month has 30, 31, 28 or 29 Days to use for the formula for the Accrued Interest.
If the debtor pays his loan as agreed, on the due date, then the Simple Interest or Rule of 78’s loans will pay the same amount of Finance Charges.
The irresponsible and unprofessional scare tactic being used on some web pages is that with Pre-computed loans, the debtor owes ALL the future interest on Day one of the loan, and that the Lendor sneakily does the Debtor a “favor” by allowing them a “Refund” on the unearned interest. Note the implication of a full payout and scare quotes in the below quote:
Let’s set this straight: Number One, the Debtor is LEGALLY entitled to only paying the Earned Interest. Calculating this, and removing the UN-earned Finance Charges, is NOT a “Favor” to the consumer, the Lender is following the LAW. What some of these so-called “Financial Experts” call a “Refund” is actually a Rebate, that is, unearned finance charges are calculated and removed from the balance before a Payoff is paid. Calling it a Refund makes the user believe that they have to pay it all, and hope that the Lender is gracious enough to give them some BACK. Websites like the clip shown below also make people believe they have to pay off the gross balance.
Anyone claiming that this “refund” is an Optional or Voluntary to the Lender are either being intentionally dishonest or are proving they do not understand Financials as well as they claim. Ditto for the claim that Rule of 78’s is an intentional “trap.” You people making such claims are actually hurting the entire industry. Interesting that Debt.org, who calls it a “trap,” sheepishly admits in it’s column, that the prepayment “penalty is really not that severe.”
BankRate.com, on the “glossary” page for Rule of 78, uses the scare tactic that a precomputed loan pays “75 percent of the interest in the first 24 months of the (48 month) loan:
OK, let’s use that comparison. Bankrate.com supposes a 9.25% APR to arrive at a 48 month loan on $15,000. The image below is a comparison of Pre-computed vs Simple Interest payments over the first 24 months of the loan. At 12 months, the difference in Total Interest earned is just $50.18, a mere 1.67% of the original $3002.82.
At Bankrate.com’s marker, the 24th payment, the difference is just $46.24, a pittance of 1.54% of the total. The Simple Interest Loan actually collects 72.95% of the interest at this point compared to the (oh, horror) Rule of 78’s 74.49%. These are NOT “taking the deed to the widow Smith’s ranch” levels of bank evil.
These sites all swoon and clutch their pearls because “people who want to pay early or ahead won’t save any money.”
Gather round me, children, and listen well, there is a secret I will tell:
People who actually pay early and stay ahead have a credit score that in all but a few unusual circumstances, allows them to choose a loan or offer of credit that suits their needs.
Pre-computed or Rule of 78’s loans are typically offered to Sub-Prime, if not Deep Sub-Prime, clients who do not seem to have an issue paying early. Quite the opposite, in fact, these people tend to pay late, and in many cases, very late, and Rule of 78’s is actually the better loan for them!
Yes, I said it’s the Better Loan! Let’s explore why before you sharpen the pitchforks. Because the finance charges on a payment DO NOT CHANGE based on the date you pay it, (hence the word Pre-computed) there is no penalty for paying a few days (or weeks) late, except for Late Fees or Delinquency Charges, which either account type would pay.
If you are 12 days late with your first payment on the above loan with Simple Interest, you will pay additional interest for those 12 days. That amount is easily calculated at:
$15,000 x (9.25%/360) x 12 = $46.25 — And that is OVER and ABOVE the other interest charged. (Ignoring Late Fees for the moment)
Now, you can pay this extra, making your payment 421.31, or, you could pay just the 375.06 payment, and let it ride. HOWEVER, if you do this, then the Principal portion of that payment goes from 259.43 down to 213.18. This means the Principal Balance for calculating Payment #2 is higher than the original amortization, and therefore the interest on that payment rises, making the principal portion lower, and that makes Payment #3 have more interest. That 46.25 will cost you 66.35 over the life of the loan, even if you pay every other payment from 2 to 48 on time. That one late payment on #1 also makes the % of total finance charges earned at Payment #24 now higher on the Simple Interest Loan.
As we saw above, 15,000 at 9.25% is $3.85 additional interest per day in the first month. I have been in or advised this industry for over 30 years, and I have yet to see a Sub-prime or deep-sub-prime lender offer a loan below 18%. Most of what I see is 28% or more.
$15,000 at 28% APR is 11.67 PER DAY. 12 days costs you 140.04 on the first payment, and letting that ride will cost you $414.05 over the life of the loan.
At 28%, the Rule of 78’s guy can be few days late here or there, and not incur any additional interest. Would we rather a person who already has credit issues be able to pay off a car, or owe one or more payments at the end of the loan?
If you want to whine about what people pay for interest, tell your legislator to fix the maximum allowable rates, not how it’s collected, especially when it’s proven that the two methods are almost within a rounding error of each other.
Go ahead, just listen. Listen to the radio ad you have, really *watch* the TV ad you paid for. Read those automated marketing emails.
Do they sound ok? Are you comfortable with the image that these things project of your dealership? If you said yes, then go get someone else to listen, watch, or read these things, and see if they agree.
Now, find out the dealerships in your area with the worst reputations and compare your marketing efforts to theirs. Find out what image you are projecting vs the Bad Guys.
The reason I venture into this topic today is because of an email I got from a high-end franchise dealer over the weekend. I’m not going to name names, because after reading the email, I have decided that this dealership has already embarrassed itself enough.
Quick back-story: I *can* change my own oil, but prefer that this dealership does it, simply because they have a great reputation for excellence and professionalism, and they wash the car as part of the deal. Best part is, I don’t have to spend my Saturday rolling around on my driveway in the heat and dirt and finding ways to dispose of the used oil myself. It also helps that their price is just a small bit more than my cost of doing it myself. Note that one of the cars in my driveway is an older 2001 Honda CRV. It’s an adequate car with good insurance rates for my 20-something college student.
So, College Boy gets the oil changed at the dealership last week, and then I get an email from the dealer’s marketing bots:
“My General Manager noticed your 2001 HONDA while you were in for service and would like to acquire that vehicle from you! We have quite a few customers looking for a vehicle like yours and are wondering if you have any interested in selling it to us or trading it in and looking at a newer vehicle for yourself?”
Really? At a dealership whose average unit price is above $40,000, you have “quite a few” customers in your Prospecting system who are pining away for an eighteen-year-old compact SUV with over 200K miles?
I also own Nissan and Buick marks, and they all go to this dealership. I have to drive past the Nissan, Honda, and Buick dealers to get to my chosen service department. I even drive past a couple of Quick-Lube type places, and three tire stores who change oil. Why? Because of their reputation. Because of the professionalism that my chosen place offers that the others just do not match.
All that image is tarnished now, because they lied to me. They also came off sounding desperate and that they would say anything to get me into the showroom.
Do not misunderstand me, there is NOTHING wrong with expressing your desire as a business owner to earn the trade of the citizens in your demographic market. Keep in mind, though that customers who were polled overwhelmingly preferred car dealers whose marketing was informative, honest, and respected their intelligence. Dishonesty, sirens in your ads, and screaming deceptive terms may grab you a few customers, but by and large they are not loyal customers, and you end up having to up the sleaze to generate the leads. Honest, intelligent marketing just keeps working.
The following suggested email would have gone worlds farther to me as a customer:
“Thank You for trusting us to service your 2001 HONDA. We would like to discuss trading you out of it for a newer vehicle, and would appreciate an hour of your time one day for a member of our Sales Team to show you what we have available, or to gather your requirements and see what can be found. Please call John Smith at 202-555-1234 or email John.Smith@FranchiseDealer.com to arrange an appointment that fits your schedule.
Thanks again for your service business, and we hope you give us the opportunity to earn your sales trust as well. ”
See that? It’s sincere, honest, and humble. It recognizes that I am a service customer, expresses appreciation for that, and requests some of my valuable time to talk. It is respectful of me as a consumer and potential sales client. Close by again expressing gratitude, and asking for an opportunity.
Consumers love to be respected. Customers love to hear appreciation. Buyers with money to spend and referrals to spare HATE being lied to. Contrary to what some of you car dealers believe, yes, they can tell. After all, some of you make it so obvious.
See you next time. Thanks as always for visiting and reading.
Yes, many of you are “informed” in that you know how and when to buy cars, what price to sell them, and know “the business” fairly well.
But there is more to it than just moving units.
I wrote a post called Where Are The Snakes?. In that post, I asked you to revise your Situational Awareness to identify the hazards in your industry, and to make a plan to deal with them.
Let’s touch on that a little more. I got a call from a dealer (let’s call him Bill) recently who had a title application rejected because he did not charge enough sales tax. Seems the county surcharge went up and he was unaware of it. Cue the angry music as he asked, in all seriousness: “Why didn’t your company tell me about this?”
I reminded Bill (nicely) that his state Department of Revenue does not notify us about these changes. They do, however, notify everyone (that includes you, Bill) with a Sales Tax Registration about these changes, and do so typically a number of months before the change will take effect. I asked Bill if he remembered getting such a letter or notification. He sputtered a bit before declaring that he “doesn’t have time” to read everything that comes from the State, because he has a business to run! Well, yes, but reading those notifications from the State are PART of running your business. If you are going to ignore the state in a business that is very heavily regulated by the state, then you are NOT running your business.
A few years ago, a dealer (we’ll call her Linda) scanned and emailed to me the letter she got from her state that informed her that they were moving to an Electronic Titling System, and it would take effect six months or so from that letter. She asked me if we were ready (we nearly were, in fact) and how we planned to notify the dealers that it was in place in the software. We did send out an email to the dealers a month in advance of the date, and let them know it was ready.
Cut to two weeks after the cutoff. My phone rings, and another Dealer from that state is angrily asking why he cant take his title app down to the tag office anymore. Seems he went there that morning and they told him to process it electronically. He wants to know how to do this. I asked him why he did not get prepared when he got the notice six months ago, and at the very least, six weeks ago when we, the DMS software company, sent him an email saying that we had his state’s electronic titling ready? Well, you see, he was “too busy running his business” to read emails or open letters from the state. I gave him the web page and phone numbers to get started. Because of his delay in getting that process going, he was late filing the title, and paid an extra fee. He told me later on he did not think it was “fair” to punish him for something he did not know about. I reminded him he had at least two chances to check into it, and surely he overheard talk in the used car community about it? Well, he admitted he had heard “something” about it, but again, “too busy running a business” to find out about it.
I will repeat this: If you are “too busy” running your business to pay attention to the governmental units regulating your business, then you should not be in business.
Over my years in this chair, I’ve seen the notices of fines about sales taxes, and the letters from the DMV reminding the dealers to process the titles. Most states require the dealer to do both. I’ve seen the levy notices from the IRS because dealers filed income taxes wrong, and the penalties from State Department of Finance for overcharging interest. These are almost always accompanied by a dealer saying “I didn’t know.” In these situations, I can usually find the information within mere moments available on the internet, not only from the State or Federal websites, but also from industry advisers discussing it.
Make time to run your business. Set aside a time each week to open and review all State Notifications. When you see an Effective Date, open your calendar and set the date, and set a reminder a month and a week in advance. Be ready.
Set aside another time each week to review the regulations for your business. Find and talk to an experienced consultant that knows your business. We’ve talked before about having an attorney and a CPA that knows the industry well. Join the business associations that can keep you informed. In our case, it’s usually your state’s Independent Auto Dealer Association. Go to https://www.niada.com/ and find your state under the “Membership By State” links. Membership is dirt cheap considering all the information they will give you. (Disclosure: I am not a member of the NIADA or any State IADA, nor do I get anything if you join.)
So, do you want to run your business, or do you want to pay fines?
Reminder: I am not a CPA or an attorney. None of the information in this article should be considered qualified legal or financial advice. It is your responsibility as a business owner or manager to obtain and retain licensed, qualified advisors for your business. Make sure you get the people who know your area of business. See THIS article.
A Related Finance Company (RFC) is simply a second company or corporation set up to collect receivables. It is either captive, meaning it only buys notes from the sister car dealer corporation, or it is open, which means it can and usually does buy notes from any dealer. Due to licensing requirements, it is not a Point-of-Sale finance operation, in other words, it does not directly offer loans to the public, nor does it make decisions on which loans can be offered. It can set limits on which loans will be purchased, and the dealer(s) are free to offer only loans to the public keeping those limitations in mind. But all in all, the dealer must initially finance the note, and in states where a Finance License is required for BHPH, hold the license to do so.
The big issue with car dealers is that since 1986, companies that hold an inventory for profit must use the Accrual method for income taxes. Prior to that, car dealers who did Buy Here Pay Here would simply use the Cash Method of taxation, allowing them to only pay taxes on the profits when collected. Accrual method has the dealers paying taxes on the sale price profits in the year of the sale. The idea, then, is to utilize an RFC to defer those taxes by selling the note with a loss. The dealer offsets current year profits with the loss, and the RFC will pay taxes on the profits later.
In most situations, the RFC purchases the note from the dealer at a discount. For example: a Deal with 10,000 amount financed, @28% APR, 36 Months gives a total payment stream of $ 14,891.04. The dealer would sell this account to the RFC for about 55% of the Total Balance, if Precomputed, or 80% of the Principal (10,000). The RFC writes a check to the dealer for 8190.07 (55% of 14,891.04).
The IRS requires that such purchase agreements be in writing, reasonable, and customary for the area. Each dealer needs to get a qualified quote from at least three companies who purchase receivables. The average rate or percent paid, quoted is the basis for the RFC-Dealer purchases. A qualified quote means that the dealer shows the note purchaser his portfolio, and gets a specific quote based on his accounts.
The Discount here is the difference between actual Principal (10,000) and the RFC purchase price (8,190.07 ) — $1,809.93. The dealer declares this a loss on the sale, and the Finance Company uses this as a (potential) profit basis. Hopefully, the dealer has made a little profit on this deal, even after only collecting the 8190.07. The RFC will incur taxes on this profit later.
The RFC is now the lien holder and the customer makes payments to the RFC instead of the dealer. Most dealers simply collect the payments on behalf of the RFC.
States typically require that the RFC file as Lien holder on the Title. If you have a captive RFC, try to do this at the time you print the title application.
Remember that the RFC *must* pay for the note. The IRS requires, among many other things, that the RFC be financially capable of conducting business, and that all transactions between the Dealer and RFC be at “arms length.” This also means that the RFC must be incorporated or otherwise registered legally as a business, have a state license where required, local business license if required, and a “presence.” Presence means existing. The RFC should have a phone number, its own bank accounts, its own files, at least one employee, and a physical place to conduct business.
The dealership should have a Contract of Sale for the Sold Notes, and make copies of the relevant contract paperwork for the RFC to have as it’s records. These records must be maintained separately from the dealership. Remember that the IRS requires the dealer to deal with the RFC on an “arm’s length” relationship. Treat the RFC the way you would treat any third-party Finance company buying your notes.
The NIADA published a guide that uses information from an IRS Field Guide the IRS Agents use to audit a car dealership with an RFC.
There are many rules and conditions to having an RFC. Loss of recognition of your RFC can lead to an assessment on the claimed losses, and potential penalties. Add to that the money already spent setting it up and maintaining it, and the dealer can be out a lot more than if he had not bothered with it in the first place.
An RFC is not a simple thing, nor is it to be entered into lightly. It *can* be used to defer taxes on profits, but should be dealt with as that. It is not a tax dodge.
Once again, consult with an experienced CPA and an attorney before taking this on.
The NIADA analytics for 2015 had some interesting statistics.
By and large, BHPH dealers are spending more on cars, and getting less down. A quick comparison to just 4 years ago(2012) shows that the average BHPH unit cost is up almost $1400. At the same time, the average down payment is down by about $125.
The good news is that average percent of accounts past due from 2012 to 2015 slipped from 28.6% to 17.6%, a significant drop of eleven percent. However, reflecting the higher costs as mentioned above, the average charge off per vehicle is up by $800. Bad debt as a percentage of sales climbed from 18% in that timeline to 25%.
Here’s the meat of this matter: Even though there are less past due accounts, dealers have higher bad debt ratios. This could simply mean that you are repossessing or managing the receivables more.
Are you in the Sub-prime business? Most say yes, but analyze your average credit score. Experian Scorex puts sub-prime at credit scores between 550-619. Anything below 550 is considered Deep Subprime.
What “business” you are in should be a determining factor as to how you manage it.
The deeper into subprime you get, the worse your collections will be. This is just simply the nature of it. People don’t have poor credit because they pay on time. Understanding and accepting this is part of the deal. The trick is how to work with them.
We said it before, you can’t just look at the score, you have to look at what makes up the score.
I’ve heard so many dealers complain bitterly about 50-60% collection ratios, but the same dealers are the ones with “Everybody Rides” posted out front in huge letters. I’m not saying you can’t have expectations, but again, you have to temper the expectations based on the customer.
I am a firm believer in working with people instead of screaming at them or threatening them. If you tell them a car is going to cost $500 a month, and they hesitate, then take that as a cue to ask more questions. Ask yourself, can I accept $425 for 42 months instead of $500 for 36 months?
Point is, find out what works for the people you have chosen to do business with. Ask. Large companies spend huge amounts of money targeting their bases. They take the demographics and desires, and retool advertising and stock to meet the needs and wants of the chosen base. There are so many BHPH dealers out there who simply stumble on the business, but make no real effort to determine what business they are in. This is a major reason why so many BHPH lots are here today and gone tomorrow.
If you realize you are in the wrong business, then it’s worth a little money to remake that business into the niche you want it to be, because you will profit rather than spend a few years losing money until you are bankrupt.
If you are a BHPH Dealer, you have to have a Collections Plan.
To start that plan, you need to decide where the boundaries are.
It is also vital that you understand your own underwriting processes. I’ve said before, Poor Underwriting leads to Poor Loan Performance.
Two questions: 1. Do you run a Consumer Credit Report on each customer applying for credit?
2. Do you know how to read and understand the report? If the answer to either of those is “No,” then we have identified the first major issue.
If you read this blog regularly, you may have seen my entry about “Everybody Rides.” The “No Credit Check” signs are a large problem. You simply cannot make an informed credit decision about a consumer from his last two pay stubs. Look, you have two choices as a BHPH dealer. Do you want your business model to collect the payments, and make a profit, or do you want to be in the repossess and re-sell business? Underwriting is the key to the first option. Lack of it inevitably leads to the second. By the way, those who make the second choice usually aren’t around very long.
Next question is, do you know how to ascertain a consumer’s availability to make a payment? Simply put, how do you find out how much money is going to be available for a payment, and how often? This is a huge key to payment collections. It is hard to collect what they do not have. Be realistic here, and leave them some room. If your payment puts them at the absolute edge of their solvency, then any small unexpected emergency for them means you don’t get paid.
Lastly, have you sold them a car they *want* to pay for? Now, this question is not a trick. Go read (or re-read) my topic on Right Sizing The Customer. Click Here. Also read the Happy Customer entry, found here.
Once you sell the car on a contract, the next bit is collecting the contract. On paper, that sounds simple, but in the BHPH industry, that is when the road gets bumpy.
First, since your customer is sub-prime, then you have (hopefully!) already understood that this person has a problem with credit obligations. I am not saying it is unreasonable to expect on-time payments, but I will say it will not be the norm.
Most BHPH customers are actually not Sub-Prime, since this designation is typically for borrowers with FICO scores from 580-670. This is the designation for Fair Credit risk. Most of these customers can get loans from institutions, albeit at a higher rate.
Those with scores below 580 are considered Deep Sub-Prime, and the credit risk is considered Poor. Quote from Investopedia.com: “Experian reports that 27% of Fair Credit category borrowers and 62% of Poor Credit category borrowers are likely to become seriously delinquent.”(Emphasis added.)
Put bluntly, that means three out of every five of your Deep Sub-Prime customers WILL be very late with one or more payments.
Some of these people work well with an early reminder or two. If your DMS has an email system that can reference the due date, schedule a Friendly Reminder for about a week in advance. So you have to set policies for “how late is too late?” and stick to them.
Picture a square area. The people inside this area are within the boundary of your payment tolerance. Make two or more larger lines outside that.
The first area between the sheltered harbor of your patience and the next line out is the “Ok, you are late, and let’s deal with it” area. Blow the whistle, ring the bell, and try to get them to wander back into the inner area.
Across that line, straying further, is the “make or break” area. Have enough rope to wrangle those strays back into one of the first two areas. The boundary to this area, once crossed, is hard to get back across.
That third area should be the last one they reach before hitting the wall that encloses your business model. The people in this area will almost never be good payers again. They reach this area for a reason. Whether it is their own decision, or the cruel hand of fate has pushed them into it (almost) doesn’t matter. They will hit that outer wall. That “wall” is the act of repossession.
So, what defines the areas? For most established first-tier finance operations, the Due Date of the payment is the first line. 10 days past due is usually the second line, and 30 days is the wall. For these companies, that Danger Zone is very thin.
For sub-prime customers, you may set your safe area line at 10 days past due. Second line is 20 days, and the Danger Zone is 21-30+. Your Danger Zone may be a bit wider than first-tier, and needs an observation post. Is the customer simply meandering in the bad areas, or are they drifting slowly outward, or, are they at a full run prison-break style?
What is the whistle? Simple (but pleasant) reminder texts and emails. Phone calls and more strongly worded emails are the rope you use to try to get them back into the fold. Remember that you own a business, and should be professional. Screaming, insults, threats, and foul language should never be used.
The faster or more determined they are about moving outward is the faster you use the tools at hand.
What about the repo wall? Here is they way I see it: It is a final wall. It should be. Repossession should not be an everyday collections tool. It should be a final admission that this loan did not work out. Remember that if you repossessed legally, then you are (typically) not required to reinstate the account. The customer has the right to accelerate the loan, and pay it off to retain the car.
Some dealers use a first temporary repossession as their rope to try to draw the customer back in, and to remind the customer of the consequences of going afoul of the payment agreement. I will hesitantly agree with this with a few conditions:
First, use your words. Make them understand your position and expectations.
Second, they get ONE temporary repo. The next one is final.
Third, there should be no profiteering (repo “fees”) getting tacked on. Remember that the laws usually allow you to recover your EXPENSES of repossession. I’ve yet to see a state or court that gladly allowed the BHPH dealer to profit from the act of repossession.
The final repossession should be a last resort.
Other tools are available. The first one is your own humanity.
Sit down with the customer, and, with an open mind, ask what the deal is. Remember that things change. Maybe the overtime the plant promised would last for a year suddenly dried up, and they are struggling under the lower income. Maybe they suffered another loss that occupied them and their disposable income for a bit. Be willing to work with people.
Maybe they don’t want to pay for a car they can’t drive because it is broken down. Work out a repair and payment plan for that.
Nothing requires you to keep extending your olive branch if they keep slapping it away, though. I asked you to be a human being, not a doormat.