You Breathe, You Drive

Many people in the United States rely on credit to purchase or lease automobiles.

Is this traditional credit allocation approach the only manner for the extension of credit? Or, are there alternatives? Is the use of alternative data a possibility for some dealers?

Some people have good credit and others do not.

Traditionally, credit scores provided by Experian, 700 Credit, Equifax, TransUnion and other credit reporting services, tell the tale.

Credit applicants, otherwise known ups, customers, and consumers, are classified by their scores, which range from 300 to 850. These credit-reporting organizations rely upon certain information to create models to yield these credit scores.

Applicants with acceptable credit qualify access capital (i.e., money) from financing sources including a bank or a captive finance company. The higher the credit sore, the more attractive the rate. In the car world, customers do not borrow money for car loans, despite what the Consumer Financial Protection Bureau (CFPB) stated. Customers sign retail installment sale contracts and agreei to make payment in exchanges for the car title.

Is this traditional credit allocation approach the only manner for the extension of credit? Or, are there alternatives? Is the use of alternative data a possibility for some dealers?

Buy Here Pay Here (BHPH) dealers have already answered this question.

Many of these BHPH dealers currently use the advertising slogan, “You work you drive,” and ignore the conventional criteria employed by the credit reporting services to determine ho should qualify for credit.

Instead, BHPH dealers rely upon other information about the customer such as the paycheck and the number of years he lived at the current residence.

Recently, the Board of Governors of the Federal Reserve System (FRB), Consumer Financial Protection Bureau (CFPB), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC) issued a statement that tepidly advocated other approaches to evaluate whether a customer qualifies for credit: “Interagency Statement on the Use of Alternative Data in Credit Underwriting.”

These prestigious agencies (with many acronyms) issued this declaration:

“The agencies recognize that use of alternative data may improve the speed and accuracy of credit decisions and may help firms evaluate the creditworthiness of consumers who currently may not obtain credit in the mainstream credit system. Using alternative data may enable consumers to obtain additional products and/or more favorable pricing/terms based on enhanced assessments of repayment capacity. These innovations reflect the continuing evolution of automated underwriting and credit score modeling, offering the potential to lower the cost of credit and increase access to credit.”

One of the examples, cited by these agencies, is the use of alternative data, such as cash flow analysis:

“Cash flow data may include a range of metrics that examine categories of income and expenses (e.g., fixed expenses such as housing, amount of variable expenses, etc.) and how a consumer or small business has managed an account over time (e.g., residual balances).”

Is this much different from relying upon a prospective customer’s paycheck and their employment tenure?

These agencies try to offer financing sources to expand credit resources to consumers while limiting risk to these financing sources at the same time. In addition, it may allow certain consumers to qualify for a better interest rate and could be used in addition to the traditional credit report.

In reality, these federal agencies emulate the BHPH model.  

The success rate for BHPH dealers is approximately 70%. In other words, 30% of BHPH customers default on their retail installment sale contracts while 70% do not. Would the use of alternative data produce this result? On the other hand, could it be utilized in other ways to improve upon this result?

A Brief History of Credit

Some form of credit has been around for thousands of years.

Babylon’s Code of Hammurabi provided maximum loan interest rates. When , Roman statesman Cicero’s neighbor bought a large parcel of land, he did it with credit notes.

In the U.S., providing credit to consumers began when local shopkeepers allowed customers to run tabs for their purchases (anyone who has ever watched old westerns observes hardware stores and saloons provided this form of credit.)

In the nineteenth century, installment credit became more popular for those who purchased home furnishings, business equipment and other relatively expensive durable goods. The purchases were paid off over time, with interest.

This trend became amplified in the automobile industry when car manufacturers expanded their operations by adding captive finance companies which employed installment lending to provide another avenue for purchasing through routine periodic payments (i.e., retail installment sale contracts). The leading example of this approach was the creation of the GM Acceptance Corporation (GMAC), established by General Motors Corporation in 1919.

A Brief History of Credit Reporting Agencies

Credit reporting companies began to form in the nineteenth century, as well, correlating with the rise of granting credit. For example, Experian dates its roots back to the 1830’s as the Retail Credit Company. Equifax began in 1899. These organizations collected information from newspapers and public records and maintained their records manually.

The Decision-making Process

In 1956, engineer William Fair and mathematician Earl Isaac developed the credit scoring system, generally used by the industry today: the FICO score representing the initials for the Fair Isaac Corporation. The factors used for the FICO Scores include payment history, amounts owed, length of credit history, new credit, and credit mix. Alternative data is usually not part of this calculus.

For the car world, the car loan credit tiers (FICO Auto Industry Option) are A+, A, B, C, and so on through F. Other versions may designate numbers: Tiers 1, 2 and 3; or metals: platinum, gold and silver. Each tier represents a given range of FICO credit scores, 300 to 850.

Credit Applications

A credit application requires a consumer to provide information about his basic identifying information such as his Social Security and driver’s license number. In addition, the applicant may be required to provide  information about assets and income. The lender may also request other information, such as residence and employment history, personal and bank references, military experience and assets.

Alternative Data regarding Credit Applications

Some of the information collected on the credit application can be considered subjective and not readily converted to a number.

This information, such as personal and bank references, could be considered alternative data and may vouch for a consumer’s creditworthiness. Creditors would prefer automation. That would leave credit decisions to computers sans human involvement. Basing decisions on alternatives would seem to require additional human involvement. However, could this other information provide consumers increased access to credit? The answer is undoubtedly affirmative and should be supported.

Personal Reflection and Conclusion

This writer has spent more than 30 years either prosecuting or protecting dealers and continues to be impressed by the creativity of dealers in solving business problems.

The BHPH industry, and other segments of the car retailing industry that use special financing, created their own models to address credit needs in the market place that major federal government agencies now recognize.

The previous administration’s version of the CFPB, under Richard Cordray, disdained small dollar lenders and BHPH dealers. Have the CFPB, and other agencies, now become advocates of industries that have served this segment of society for generations with alternative data? It would appear so.

GOVERN YOURSELVES ACCORDINGLY.

Terrence J. O’Loughlin, J.D., M.B.A. is director of compliance for The Reynolds and Reynolds Company. Prior to joining Reynolds, he was employed by the Office of the Attorney General, State of Florida.