Lack of Under $10k Cars Represents an Opportunity for LHPH

Automotive News recently published an article entitled, “Dearth of recession-era vehicles puts budget-conscious buyers in a bind,” which exposed an issue in the subprime automotive finance market that is quickly becoming a real challenge, particularly for Buy-Here, Pay-Here dealers.  (Link at the bottom)

Due to the cut back in the production of new cars during the Great Recession, there is a glaring lack of supply in today’s market of vehicles below the $10,000 ACV mark.  These vehicles have traditionally been the bread-and-butter of the BHPH world to provide deep subprime customers with reasonably affordable monthly payments.  The need to keep terms short to reduce loss frequency and severity, and the necessity of an interest rate sufficient to cover the risk inherent in a BHPH portfolio, requires a dealer to sell lower ACV vehicles.  You cannot place a deep subprime customer in a $600 per month payment with a 35% PTI and expect that loan to perform. 

In addition to the supply crunch forecast for the next 5 years, the ever-increasing price of new cars continues to hit new records year-over-year.  Consequently, the average price of used cars follows in lock-step hitting new heights every year. 

The challenge then, is how does a BHPH dealer compete in an environment where the supply of their primary product is limited, highly sought after, and for which the average age and mileage continues to climb? 

One answer to this question is the Lease-Here, Pay-Here model.  As illustrated in the graphic below, the lease product allows a dealer to offer the same monthly payment to a subprime customer on a larger dollar vehicle at the same term and rate.  As an example, a dealer can offer the same payment on a $11,000 cap cost lease as a BHPH dealer can offer on a $9,000 installment contract with the same term and interest rate.  The same holds true with a $14k LHPH deal and an $11k BHPH deal.  

As the price of used cars rise and the availability of low ACV cars becomes squeezed, dealers who offer a LHPH program can purchase newer vehicles with lower miles and still maintain the customer affordability that is so critical in the deep subprime lending market.  The need to reduce the quality of the asset or stretch the average term and inject risk into your BHPH portfolio is removed through the benefits of the lease structure.

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