Bark's Bites: The Plight of the Sub-Prime Customer

“Mr. Smith?” The Finance and Insurance manager, a genial but tired-looking man, stuck his head outside the door of his office.

“Yes?” Mr. Smith, known more affectionately as “Dad” to his two children, and “John” to his wife and friends, jumped nervously to his feet.

“My name is Andy Marshall. It’s my job to walk our customers through our financing process. Please, come into my office and let’s talk a bit.”

John had been sitting in that chair for what had seemed like hours, watching through the glass of the finance office as the F&I manager had made numerous phone calls, looked at reams of paperwork, and even sent faxes. He knew his odds of getting financed on a newish car were slim, but he had friends who had been to this dealership before who had even worse credit than he did and they had been able to leave with a car. So maybe there was hope after all.

Bad credit. Honestly, those were two words that John had never thought would apply to him. Back before the recession, he had been steadily employed his whole life—even upwardly mobile. There had been the first round of layoffs, but those were almost an excuse. Everybody knew that corporate had just been looking for reasons to get rid of certain people. But then there was a second. And a third. And, finally, a fourth.

That fourth layoff was the one he couldn’t escape. So there he was, a suddenly over-qualified, over-educated candidate for nearly every job out there. The savings evaporated quickly. Bills that used to get paid automatically now drifted into 30 day status. But he found another job, albeit one that hadn’t paid quite as well, so he was able to scrape and claw and catch everything up to a “current” status. Nothing had gotten TOO out of control, and although he had to use some credit cards to survive during that period, he had been able to salvage at least part of his credit.

The killer had been the car that he had to get when the twins showed up. John’s little Mk III VW Jetta was no match for everything that comes along with twins—two strollers, two diaper bags, two of everything—so they had gotten a 2008 Chrysler van in 2012. Unfortunately, his FICO score had slid all the way down to 610, so the only loan he could get was at a crippling 14.9% rate. To make the payments affordable, the loan had been stretched out to 66 months. That meant that he had barely paid any principal at all when the transmission started having troubles in 2014. The quote from the shop to fix it was ridiculous, but they had suggested that he might be able to trade it in on a newer model.

And that’s how he ended up in that Finance office that day. John was nervous, even a little afraid, of what was going to happen.

Andy picked up the phone. “I’m going to page your salesman in here. There are a few hurdles we need to overcome.” Immediately, John felt a gushing of bile leap up from his stomach into his throat as Andy used the dealership intercom to ask his salesman, Jimmy, to come into the office.

“What’s up, Andy?” Jimmy came into the office and sat down in the chair next to John.

“I wanted to bring you in because we might need to look at another vehicle.” Andy slid some paperwork across the desk for Jimmy to take a look at.

“Oh, man.” Jimmy looked at the papers with a grim stare. All joviality had disappeared from his face.

What is it? What do the papers say? John wondered.

“Mr. Smith,” continued Andy, “We have lenders who we work with on what we call ‘special financing.’ I’ve been able to procure financing for you on that 2011 Odyssey you’re looking at, but only if we can get twenty percent down from you. Are you able to do that today?”

“Twenty percent?” cried John. “That’s going to be like four thousand dollars! I don’t have anything like that!”

“Well, then, we might have to look at something a little less expensive. Jimmy, do we still have that 2008 Odyssey available?”

“2008?” John shook his head. “That’s no better than what we already have. What’s the problem with getting the financing?”

“Mr. Smith, you have a considerable amount of negative equity in your van. We can’t find anybody willing to roll that negative equity into a loan for you on the 2011, considering your credit history. But we have a little more wiggle room on the 2008.”

John, visibly flushed, stood up. “No, thank you. I think I will try somewhere else. Thanks for your time.”

Before anybody could say another word, John walked out of the office, and down the hall to where his sputtering van sat waiting in the repair bay. How did I ever end up here, he thought. How did I ever end up here?

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A story like this might normally end up in Sunday Stories. Unfortunately, this story isn’t fiction for the millions of sub-prime buyers across the country. The credit bureaus generally consider anybody with a FICO score of less than 620 to be “Sub-Prime.” There is no shortage of lenders willing to make car loans with rates around 15% APR to borrowers with 550-619 credit scores, and rates over 20% to “deep sub-prime” customers with scores under 550. In fact, many industry analysts would consider there to be too many willing lenders. According to Experian, sub-prime loans now account for over 27% of car loans, the highest number since they began tracking such data.

In short, for sub-prime buyers trying to get a new car, it’s not a financing problem. It’s an inventory problem.

When lenders are considering a loan for a subprime buyer, they look at the price of the vehicle being financed and they compare it to black book values. Whereas a Tier 1 buyer might get approved for 125% or more of book, a subprime buyer might only get approved for 85-100% of book. Obviously, if a customer has no down payment, or if he has negative trade equity, this becomes a problem for both the customer and the dealer.

Anybody who has ever worked at a dealership has at least a dozen tales of a subprime customer who landed on a car, was sent to the finance office, and was immediately told, “Sorry, you don’t qualify to buy that car. We’ll have to find you a different one.” Imagine that you’re that customer—how excited would you be to be bumped to a less expensive car (or, more likely, one with a bigger margin on it)? How likely would you be to just extend your middle finger to the F&I manager and head to a different store?

Most car dealerships don’t separate their subprime business from their regular business, even though they are two different businesses and need to be managed as such. Obviously, this includes their inventory, as well. If a dealer paid market value or above for a piece of inventory, whether it was a help make a new car deal work or because a bidding war took place at the auction, there won’t be enough margin between book and retail for the dealer to price the car appropriately. As a result, the lender won’t approve the deal.

However, if dealers had a way to identify sub-prime inventory at an auction, and could then match customers to inventory based on the customer’s credit profile, all this could be avoided. But how?

Check back with me in a couple of days, when we’ll discuss a new piece of software that might just change the way this entire segment of the business works.