Credit Acceptance Corporation: Educating Dealers

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Could you provide a short introduction to your background?

After serving in the military for eight years, I got into the automotive industry. Initially, I sold cars and, over the course of 17 years, held every sales position in the dealership, up to and including general manager of a multi-franchise store. In addition to selling cars and managing people, I also secured loans for people with both prime and subprime credit. I was getting ready to open my own store but ended up accepting a job offer from Credit Acceptance and suddenly I could work Monday through Friday, making less money, but without risking my entire life savings and I would not be working 12 to 14 hour days, six or seven days a week.

We had children entering high school so I opted for that. Within Credit Acceptance I grew the market over 300% each year and was promoted to regional director of sales. I managed multiple states and was responsible for hiring, terminations, development training, coaching market area managers and growing and expanding the market. The only reason I left was because my wife and I had relocated to Idaho with my promotion to director of sales, and our grown sons had both moved back to Southeast Washington. ACV Auctions head hunted me to be their director, which prompted my leaving Credit Acceptance to be closer to the kids.

Can you explain the traditional process of underwriting subprime loans?

A traditional deal looks at the value of the vehicle and how quickly it depreciates. The auto loan is structured based on what the customer buys, how much they put down and if there are additions such as vehicle service contracts. The lender will forecast, over six-month increments, the depreciation based on payments received to find where the saturation point is. They always want to be in an equitable position and will calculate how long it will take and balance that against the credit worthiness of a customer.

Would the lender provide 100% of the loan up front to the dealer?

Yes, with prime and good credit; whereas subprime credit is slightly different. Unfortunately, most lenders who offer subprime credit have a poor grasp on how to mitigate risk, which is why they always struggle. Most of them limit risk by going as short term as possible. They also charge much higher interest rates because that is based on the risk associated with the loan. The more risk there is, the more interest they charge. A good credit customer would get 60 months at a low interest rate, but when interest rates climb up to 30%, which most subprime lenders do, they cut it back to 36 months which make the payment way too high.

With high interest rates, customers realize, after making six to eight payments, that almost everything they have paid goes to interest and they have made no headway. This makes them more open to disengaging because they feel they will never pay it off. Traditional subprime lending goes as short as possible in the term and as high as possible in the interest rate to secure a profit margin, while charging dealers a fee for doing business with customers who have bad credit. If a customer purchases a $15,000 vehicle and puts $1,000 down – and for easy mathematical purposes we will ignore taxes and additional fees – the loan will be for $14,000.

Most subprime lenders will short fund the dealer and charge them an acquisition fee between $2,000 and $3,000 for a person with really bad credit. The dealer only receives $11,0000 or $12,000 of the $14,000 being financed. In that way, subprime lenders put themselves in a safer position in that they’re charging the dealer a fee for doing business with someone with bad credit. Coupled with that, it is short term, high interest and high monthly payments, which fosters disengagement from customers.

How does that advance rate compare to what Credit Acceptance offers?

Credit Acceptance typically offers the same. The difference is that regular subprime lenders get a $3,000 fee, so on a $14,000 loan the dealer receives $11,000 up front. They will probably also be on the hook for six months for a payment default clause, meaning if the customer misses any of those first six months of payments, the dealer has to buy the contract back and honor the terms of that contract. $11,000 is all the dealer will ever get; there is no end game. Unfortunately, that causes dealers to do what I like to call 'putting lipstick on the pig'.

They try make it better than it is. If a customer has nine months on their job, the sales person rounds it up to a year on the credit application to show more stability. If a customer makes $1,500 a month, they round it up to $1,700 which makes the disposable income look better. This results in drastically inaccurate data from which lenders base their risk assessment. It is their job to inspect the data and assess the risk accurately, however information falls through the cracks. On that $14,000 loan, Credit Acceptance might fund the dealer $11,000 or perhaps $1,000 less, however there are several big differences.

There is no payment default clause; if a customer misses a payment, the dealer does not have to pay back the advance. If they gave them $10,000 instead of $11,000 the dealer is at a $1,000 disadvantage by using Credit Acceptance over other lenders. The difference is that once Credit Acceptance has collected $10,000 in payments, the dealer can earn back the fees associated with that contract, and will receive 80% of every payment made. This makes it more of a partnership with dealers which encourages them to give accurate information to allow the system to accurately assess the risk which affects how that contract performs. If that contract meets or exceeds expectations, dealers receive additional funds, as opposed to the funds which line the pockets of every other subprime lender who operate their business traditionally.

How does that change the dealer margin in the short term? Are used car dealers encouraged to effectively mark up the car?

The difference is you cannot mark it up because you will only get $12,000. You are limited based on what the lender will finance. Credit Acceptance allows dealers more control to structure deals because everything they do can increase or decrease the amount of risk on that loan. If a good credit customer gets a 60-month term and a bad credit customer gets a 36-month term, Credit Acceptance would offer 48 months. With any change to the car deal, dealers can see how it increases or decreases the risk.

As they make changes to the loan and decrease the associated risk, they are rewarded by getting funded more money. This trains dealers to build car deals in a manner which provides less risk for both parties and offers customers more affordable payments. With other lenders, when you lower your selling price, you give up profit margin, but with Credit Acceptance a dealer can lower the selling price by $1,000 and make $700 more up front on day one.

Lowering the price by $1,000 brings down the monthly payment by roughly $30, making it more affordable for the customer. They could lower the price by $700 but add a vehicle service contract, so if the vehicle breaks, it gets repaired and all the customer is at risk for is a $100 deductible instead of a $1,400 repair bill. They can now continue to make those loan payments without getting into a financial pinch. Credit Acceptance teaches dealers to create deals with less associated risk to achieve the best performance because that gets them more money up front and a bigger portion of profits later.

Why would dealers choose Credit Acceptance over other lenders?

A big part is knowing you will make more money later which creates stability. Many dealers run a buy here, pay here business and avoid banks. They collect all the interest and make money throughout the life of the loan, which is substantial with bad credit customers. On a long term 66 to 72 month loan, with high interest, there might be $10,000 in finance charges. Taking $2,000 less on day one, with a possibility of an extra $6,000 later, makes a huge difference.