The 80-20 Rule in BHPH

I have been consulting and training in the buy here-pay here world for over 10 years now and continue to have the same discussion with dealers who have been in business 30 years or 30 minutes. That discussion revolves around of the importance of underwriting in the buy here-pay here process.

The discussion with experienced dealers goes something like this: “We were experiencing some really bad delinquency and charge-off rates so we fixed the problem by tightening up our underwriting.” The discussion with the new dealer goes something like this: “Collections won’t be a problem because we will analyze our results and create a model that will tell us who will pay and who won’t.” Both statements create great discussion and debate, but what is the truth?

I am a very analytical person by nature and spent a good portion of my buy here-pay here life attempting to find the answer to the question of who will pay and who won’t. I thought I could absolutely create a scoring model that would not only be predictive, but would guarantee successful underwriting. Try as I might I failed each and every time. This is not to say that you can’t buy or create a scoring system that is predictive. This has been done over and over again. The best scoring models can predict with some accuracy what percent of loans will pay out given weighted criteria and historical experience, they just can’t tell us which ones will pay out on an individual basis.

So should we discard scoring models all together? Absolutely not! They can serve a great purpose. They standardize your process and aid in the elimination of emotion and feelings about loan applicants. The only piece of advice I must give each of you is that no scoring model will be predictive if you don’t verify the facts the score is based upon. That sounds simple but I see too many dealers making decisions based on unverified facts.

The experienced dealers who change their collection results by “tightening up” their underwriting intrigue me. My thought is that if just tightening up changed your results why wouldn’t you just stay tight all the time? And just what did the dealers do to “tighten up”? Did they change their employment requirements? Did they change their residency requirements? Did they change their income requirements? Did they change deal structure? How do they know these changes worked? When will you know the changes worked? Will you know in 10 days, 10 months or 10 years?

I challenge the notion that you can just flip an underwriting switch and get instantly better results. If that were the case, all the kids would be doing it. I think the first step to better collection results is to understand that we really don’t underwrite in the traditional sense of the word. Most of the information gathered to make “decisions” is really just a verification process of facts about the customer that will aid in the collection of that customer and not to make decisions. I know that some answers given on a credit application or in interview are deal breakers such as, are you employed? Answer: nope! That is easy, but what is the difference in loan success rates between 9 month jobs and 13 month jobs? How much difference will 6 months more on a residence make in the collection of a loan? So am I saying throw the underwriting process out the window and use the mirror-fogging method of days gone by? Absolutely not! It is imperative to create underwriting guidelines and more importantly you must abide by them each and every deal. That is the only way you can ever glean information to make better decisions in the future. The underwriting process must also include verification of the facts on each and every deal. Without verification of the facts, you are playing roulette.

How does the above information apply to the title of this story: The 80:20 Rule for Buy Here-Pay Here? It goes like this; Your success in buy here-pay here will be based 20 percent on your underwriting, verification and loan closure policies and procedures and 80 percent based on your collection policies procedures and your adherence to those policies. How did I come up with the 80 percent number? I don’t know if that is exact but we use the 80:20 rules in so many other aspects of our lives and businesses that I used it as well. The numbers may not be scientific but my experience and the observation of thousands of clients has led me to this conclusion. Think of my theory in these terms: If you are the world’s best underwriter (BHPH) and terrible at collections, how will you do? Or, if you do no underwriting but are a superior collector, will you succeed? My experience says that great collecting overcomes marginal underwriting but the reverse is never true.