July 17, 2023

Use Rate-for-Risk Finance Models to Increase Business

As companies look to reinvigorate used car financing, it’s time for a more personal approach to interest rates based on individual circumstances

With the running costs of operating dealerships increasing in the last 18 months, retailers are focused on improving profit centres. One method that’s propped up revenue has been income from finance agreements. New car finance income has been nominal due to marketing schemes operated by OEMs, but used car finance at the point of sale is without doubt under more threat.

The FCA’s ruling back in 2021 that removed car retailers’ ability to manage the rate offered to customers was a sensible decision and meant that all customers would be treated fairly. But this change has started to impact finance penetration due to point-of-sale interest rates set at a higher figure than the more savvy customer could acquire elsewhere.

This has been compounded by the interest rate rises we have seen over the last 12 months, meaning that showroom prime rates are now double-digit, averaging between 11.9%-12.9% APR. Consequently, more customers are thinking again and will try other sources for financing their car purchases.

In addition, as online sales remove the opportunity to speak directly with a customer about finance options, a difficult picture is emerging. One way of increasing finance earnings is to discuss with the finance provider a lower fixed APR to offer all customers at the point of sale. But this means reducing the level of commission per agreement, with no guarantee it will increase finance penetration to reach the same level of income prior to the legislation change. Car retailers will be doing the maths as a number are expressing concerns over finance penetration.

Rate-for-Risk Model

The majority of car retailers are still choosing to offer a fixed prime interest rate, but is it time to move to a ‘rate for risk’ model, where customers receive an interest rate commiserate with their personal credit rating?

This does have drawbacks, as a car retailer will need to promote a ‘typical’ rate on their website and other sales channels, knowing that some customers will get a better rate than others. Budgeting examples in the showroom will need to take account of this situation and can potentially cause disappointment to the prospective customer. But the FCA’s Consumer Duty asks that all processes need to be reviewed and assessed as to whether they provide a good outcome to the customer.

Providing the process is clearly explained to the customer, this should enable car retailers to offer attractive finance offerings to creditworthy customers and, in turn, see finance penetration improve. This is more relevant for premium brands, where more customers have access to other means of financing their car purchase.

But the move should also be effective in the volume car market, where consumers are being enticed by offers from their bank and other online B2C companies. Some banks will offer PCP through their motor finance arm, making the offer compelling when linked to a low interest rate.

Benefits are at both ends of the credit spectrum since the ‘rate for risk’ model should also enable car retailers to fund a wider range of credit profiles. This means that some customers that would have failed the prime fixed rate offer could be funded and increase finance penetration.

I would also agree with F&I professionals in dealerships who say that the traditional benefits of ‘in-house’ finance remain. It’s a simple and quick but careful process which has the support of a finance company in the event of any unresolved post-inception issues with the car, plus a range of products to suit the customer’s personal requirements, leaving the bank facility free for other needs.

Have the Talk

Retailers need to have a conversation with their finance panel and get some examples to work through. Any change comes with risks, but to do nothing is more dangerous. The problem also impacts the motor finance companies as they also have fixed costs to cover, and lower finance volumes mean less profit.

But the companies have to balance this with ensuring that they are ultra-diligent when underwriting a customer since an assessment of affordability and ability to pay is crucial to prove that their decisioning is fair to the customer. Both parties should have the desire to discuss the way forward in these challenging times.

This article was originally written by Peter Cottle and published in the IMI MotorPro magazine.

For more information contact:

Peter Cottle, Consulting Director, Finativ

e-mail: peter.cottle@finativ.co.uk

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