Buy Here Pay Here (BHPH) is a term most commonly used in the automobile industry. Meaning that the company from which you purchase the vehicle is also the same institution that will carry the note on the loan. Therefore, no bank approval is necessary to purchase a vehicle. Many terms are synonymous with BHPH such as sub-prime contract holding, carrying the note, or in-house financing. The average FICO score of a BHPH borrower is under 560, which prohibits them from using traditional financing options. Often a BHPH loan is the only recourse for an individual with sub-prime credit. Typically, down payments are required up to 30% of the purchase price in order to receive BHPH financing.
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The BHPH Industry originated primarily in the early 1970s during the savings and loan crisis. With many similarities to the current financial crisis (2008 – present) credit was difficult to obtain, unemployment was rising & the economy was still in a transformation from a production-based economy to a service-based economy.
Automobile dealers who still wanted to sell cars had to find a way to deal with the increasing price of vehicles relative to income. They had to sell these vehicles to wary consumers who were unwilling or unable to pay 'cash' for the new purchase. In many cases, when banks would not loan to the consumer, the Automobile dealer would start a related finance company (RFC) and have that finance company approve the loan on the vehicle. This was a bold step into the banking business for automobile dealers. The advantage to the dealership of having an RFC finance the sale was decreased risk on the sale and finance of the vehicles sold. Since both companies had the same ownership, dealers could now essentially benefit from the profit on both the sale and the loan for a single vehicle. Additionally, the down payment required on a BHPH loan generally larger than the total profit on the sale of the vehicle. Therefore, if the buyer didn’t make payments, the RFC could repossess the vehicle and sell it again at the dealership. Many of the benefits of separating the RFC out from the BHPH dealership are based in the tax code changes of the Tax Reform Act of 1986. In that act it restricted any companies that utilize inventory in their operating business from using cash accounting.[1][2]
One difficulty that the dealerships have is cash flow. Often, used car dealerships purchase inventory with a floor line of credit. The most common flooring line is either a standard line of credit from a bank that is secured with other collateral such as real estate, or it is a line of credit (MAFS) from the nation’s largest automobile auction house Manheim owned by Cox Enterprises. Typically flooring lines require the automobile to be paid off in full within 90 days of purchase. This means that automobile dealers are operating on the banks money and are trying to turn units as quickly as possible so they don’t have to pay off the loan on their inventory before they sell it. One difficulty that this presents to BHPH dealers is that when they sell a vehicle to a BHPH customer the RFC needs to produce the loan funds so the dealership will have the funds to pay off the line of credit on that automobile. Often this ‘cash crunch’ is the primary reason for dealerships to go out of business.
As the Savings & Loans crisis started to abate in the mid-1980s the Buy Here Pay Here industry started to move its focus towards consumers with lower credit ratings, and today BHPH has become known as ‘bad credit’ approval. As automobile dealers began to see a significant portion of their business coming from the BHPH industry the need for lending systems and software increased. Most automobile dealers were great at selling, servicing, and repairing vehicles but did not know how to run a finance company.
The lending industry has many new regulations and rules that dealers are not used to. Although the RFC’s are not regulated as strictly as banks by the Federal Reserve they are regulated by the Department of Financial Institutions or Department of Commerce on a state level depending on the state. Many of the regulations vary by state such as the maximum interest rate, late fee amounts, grace periods and so forth. Some of the companies that have started as RFCs have grown large enough that they became Industrial Banks which are FDIC Insured banks owned by non-financial institutions. These are primarily used for credit card companies such as American Express, or Auto Loan Companies such as BMW Finance, or GMAC Finance, most of which are chartered in Utah.[3]
The Federal Trade Commission (FTC), the federal bank regulatory agencies, and the National Credit Union Administration (NCUA) have issued regulations (the Red Flags Rules) requiring financial institutions and creditors to develop and implement written identity theft prevention programs, as part of the Fair and Accurate Credit Transactions (FACT) Act of 2003. The programs must be in place by November 1, 2008, and must provide for the identification, detection, and response to patterns, practices, or specific activities – known as “red flags” – that could indicate identity theft. The Red Flags Rules apply to “financial institutions” and “creditors” with “covered accounts.”
Among the difficulties that RFC’s of BHPH dealers have is complying with federal,state and local regulations & ensuring accurate loan calculations. Originally, the popular way to calculate loans was at origination to print off an amortization schedule and then to simply check off each payment once it was made. This is inaccurate as payoff may occur early, payments may not be the exact amount on the due date, etc. Later a few DOS-based system were implemented that could pull reports and do calculations. These systems were user based (restricted the number of users) and specific computer bases (you had to install it on each computer you wanted to us it on). Recently the software industry trend has been to move all software applications online. This trend has been very useful to BHPH dealers & RFC’s. Recently with many of the financial regulation changes small dealerships and sub-prime lending companies have become very dependent on the cutting edge software companies to provide Red Flag Rules compliance, fully conform for credit bureau reporting regulations, full disclosure, regulation Z, Truth in Lending Disclosures, and many more government requirements & regulations. Banks & Credit Unions most often & frequently produce their own in-house software applications.
Buy Here Pay Here seems to be one of the only areas of the Automobile Dealers industry that is surviving this recent economic downturn of 2008-current [4]. Automobile manufactures, new car dealers, banks & auctions have all suffered immensely over the ‘worst time for the car industry ever’. BHPH potential clients seem to be increasing by the thousands, those whose credit is now deteriorated due to the housing collapse, unemployment, or a thousand other now common place situations. Banks still have not loosed up lending and dealers seem to have the only way they can turn cars on their lot is to send it to their RFC. As the industry begins to stabilize many industry experts say it will be the BHPH dealers that come out on top.