How to Stock Subprime

A fundamental of subprime financing and auto sales is maintaining the appropriate inventory. What defines “appropriate” inventory? It will be driven by a number of factors.

Consider the credit situation in your market area. Profile the percentage of B, C and D paper your dealership typically sees and, based on that, mirror your inventory to what you should sell.

If you have been actively involved in subprime, an easy way to profile your market is to pull a report or gather data on your funded deals across the last six months by lender by tier. You will see where your paper falls.

Here's why that's important. The inventory needed for each segment varies. A near-prime customer has more available finance options and typically will be more selective in purchase decisions. Discount fees and rates for these customers will be lower. To sell to them, you will need vehicles that meet their wants. For this customer, what sells good new, sells good used.

The deeper subprime or captive credit customer is not in a position to be as particular. For these customers, consider not so much what is “hot,” but what carries the largest margin between wholesale purchase price and your lender's retail book advance or percentage of like invoices (for current year models).

This is necessary not only for the sake of profit, but also to insure you can cover the higher fees associated with those customers. For the captive-credit customer or a customer carrying negative equity, look for those vehicles that were “cold” when selling new. As a used vehicle, they can usually be bought well back of book. Purchase your inventory to mirror your credit mix. You will deliver more vehicles.

Selection will be driven by the average income in your market. Vehicles should be inventoried to match not only your customer's income and budgetary constraints, but also your lender's underwriting guidelines.

Average income is critical when considering which inventory is appropriate. Most lenders allow 20% of gross income for a payment. An $1,800 monthly income means a maximum payment of $360 a month.

The payment and therefore the unit that should be stocked for a metropolitan area with higher income will differ from that of a rural area with lower income.

Your inventory should be priced to meet the income of your customers and deal structure of your “worst-case” lender. If your customer is approved under a more favorable call, it will only mean your gross profit improves.

After looking at average income, consider your lender guidelines. Start by looking at restrictions for year, make and mileage. One dealer I know looks only for late model vehicles with under 30,000 miles to minimize these issues. Above 50,000 miles, and you may have problems with deal structure.

Make note of criteria for vehicles to qualify for extended terms of 72 months. Be aware of flexibility as it regards to credit quality. Also watch for restrictions on advance. Finally, be conscious of which book (i.e. NADA vs. Kelly Blue Book) your lenders allow you to use to book out a vehicle. An allowed difference in book value can make a difference in a unit being appropriate for a subprime customer.

I'd suggest creating a matrix that looks at income for your market along with terms and discount rate for your “worst-case” lender. Do you know the average income in your market area? If not, e-mail me with the name, address and number of your dealership and I'll be glad to provide you a free report with that and other valuable information.

The majority of marginal credit customers need to purchase used vehicles due to budget limitations. Vehicles need to be purchased far enough “behind book” to afford discount fees and yet still enjoy significant profit.

Some new vehicles will be sold to subprime customers. I know franchised dealers with lower price-point vehicles that drive new car sales through captive credit customers.

But subprime is largely based on pre-owned sales. The lower price points and gross profit associated with used vehicles better match the payment restrictions and deal structure subprime requires.

Tim Shea is president of Great Direct Concepts, a subprime consulting firm. He is at [email protected] and 800-430 5484.