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The auto retailing world is currently consumed by the CFPB’s threats to unleash new regulations aimed at curbing potential discriminatory lending practices – and reduce or eliminate dealer participation in the finance contract process. The saber rattling from every side just gets LOUDER. On the dealer front, there is understandably much emotion, but the focus has narrowly been on what will happen to the money, money, money - with no discussion of what the elimination of dealer reserve would logically mean for the current sales and financing process.
No matter what transpires, it’s always good to think things through. Dealers and lenders need to be prepared, given that legal analysts - even for major dealership magazines -have included in their 2014 industry forecasts that “discretion with respect to dealer participation (will) dwindle (maybe out of existence) as a result of CFPB pressure on finance companies.” Legal analysts note that, “finance sources are already telling dealers they ‘might’ have a discrimination issue on their hands.”*
So, let’s shut out all the noise and fear for just a moment and rationally consider what the nixing of dealer reserve would mean, at the most basic level, for the current dealership sales and financing process.
To do that, let’s quickly review how, in our dealer participation world, cars are now bought and financed…
First, we all know that consumers have to slog through time-consuming stages on the dealership sales and financing “game-board”: trudging from test-drive, to sales department, to last stop, F&I. And we know that in F&I, because of the dealer reserve model, this is how it goes: managers use educated guesswork (after eyeballing the customer’s credit history and flipping through their pile of lender rate ‘sheets’) to set a financing rate. They then “spray and pray” terms to multiple lenders, waiting for those lenders’ mysterious ‘black boxes’ (where real pricing and unique credit policies/parameters are locked up), to return finance terms that deliver the biggest dealer profit. Dealer participation is, of course, the difference between the lender’s approved interest rate (the “buy rate”) and the APR the dealership wrote the vehicle purchase contract at. A manager assumes that customer is Tier 2 credit qualified, writes the rate up at 7%, chooses the lender that returns the lowest buy rate, such as 5% – and profits with that 2% spread.
Note here that this archaic, guesswork-based model happens without any involvement on the part of any lenders (and without any human’s ability in F&I to master all the complexities of multiple lenders’ loan parameters and rules). So, the upshot is that a percentage of loan deals either unwind or have to be completely rewritten. This is a costly, time-consuming headache for all parties: consumers, dealers and lenders.
The Process in a Post-Reserve World: There is one overwhelming fact about how the sales and financing process would change in a post dealer participation world: the negotiation of finance terms, monthly payments and interest rates without lender involvement will no longer be practical. The lender interest “buy rate” will NECESSARILY become one and the same with the consumer contract interest rate/APR. Dealers will have to determine the lender and final loan approval terms BEFORE contracting with the consumer, so the financing “piece” will move right up to the point of the sales negotiation. If it didn’t, a dealership would suffer an impossible proliferation of purchase contract re-writes, unwinds and reduced profit. The old system of interest rate guesswork and shot-gunning of loan applications at the end of the “game” will not be sustainable. You won’t be able to have managers writing contracts at 7.5% with the best-priced lender coming back with a 6.5% rate. For dealers to be able to structure a finance deal, lender approval terms must be known, done, locked up and transparent at the point of sale – whether that’s online or in-dealership.
We all know the CFPB is looking towards replacing dealer participation with a flat-fee model to dealers for handling the finance purchase contract process. We all know dealerships provide hugely valuable services (for lenders and consumers) in financing, and dealers will still get paid and profit. And if CFPB regulations come to pass, we may see set profits on each loan getting pre-loaded by dealers – but based on amount financed, not the customer’s credit qualifications.
This short exercise in reviewing how the current sales/financing process works - and how that would most essentially change in a post-dealer-participation world, shines a clear light on how crazy and broken the current process is – and how, at a very fundamental level a post-reserve model could ultimately benefit dealers. It could make them far more efficient, and, yes, profitable. When you move the financing to the front of the sales process and eliminate all the dealer-lender back-and-forth it. by nature, creates a radically more streamlined, integrated sales and finance process – and one that could reduce the total transaction time from hours to minutes.
At the recent NADA convention, emotions over the CFPB ran hot. But another hot topic was how the sales process simply needs to get more efficient. A study was presented showing the current purchase transaction takes a whopping four hours** with the report’s author noting, “It’s frightening…how much time is being wasted on the typical car sale. It’s a wonder…the dealership manages to make any money.” Leading dealer sales consultants like Grant Cardone argued the way cars get sold simply needs to change, and speed up, because people are “irritated” and don’t even want to come into the showroom anymore.
Very few have connected the dots between these two “hot topics.” If the CFPB acts to eliminate dealer reserve, final, approved loan terms must be in place at the point of sale, and the costly guesswork and irrational shot-gunning of loans must end. This would rationalize the whole process and it would certainly make consumers much more happy, and more likely to finance with dealers. And if the CFPB doesn’t act, change still has to happen. We’re at a real crossroads with the sales and financing process – and I believe it’s welcomed, and nothing to fear.
*F & I Magazine, “5 Regulatory Predictions for 2014,” by publication’s ‘legal insider,’ January 2014.
**Field study of 200 dealerships by consultant Mark Rikess, reported in Automotive News, February 2014.
By Pete MacInnis, Founder & CEO, E-Lend Solutions (a DealerCentric company)