Lenders get into buy-here, pay-here car business

photo Staff photo by Dan Henry/Chattanooga Times Free Press. Michael Reed, lot manager, checks inventory in the lot at DriveTime, a new buy here, pay here car dealership, which has been open since October of this year. The Chattanooga location is the second in Tennessee with two more proposed to open before the end of the year.

Auto dealers who cater to consumers with bad credit are finding financial success by offering to make loans to people with a history of not paying their bills on time.

That's music to the ears of consumers with a low credit score, who are flocking to buy-here, pay-here auto dealerships to buy a car to drive to work and rebuild their ruined credit score.

But industry officials say about one in three vehicles sold this way is repossessed, leaving some customers deeper in debt, and with no car to get to work.

A growing number of auto dealerships that eschew traditional bank financing and instead finance car loans in-house, like recent local arrival DriveTime, are sprouting up everywhere, said Ken Shilson, founder and president of the National Alliance of Buy Here, Pay Here Dealers.

Rapidly Growing Sector

"There are potentially 100 million Americans that have a credit score under 600 or no score," making buy here, pay here "the most rapidly growing segment of the automotive industry," Shilson said.

The percentage of Americans with credit scores below 620 has grown to 25 percent in 2010 from 14 percent three years ago, according Jack Tracey, executive director of the Community Auto Finance Association.

"A lot of dealers are getting into [buy here, pay here] now because they have customers who want to pay, but the national credit tightness is reflected in the auto finance industry," Tracey said. "The people that come aren't so much looking for a car as they're looking for transportation. Whether it's a Chevy or a Chrysler, it doesn't matter."

Lenders Dressed Up as Car Lots

Buy-here, pay-here dealerships are as much finance companies as they are auto dealerships, said Jon Ehlinger, DriveTime's executive vice president and general counsel.

"Most of our employees are noncar sales people. They have little to no car experience," said Ehlinger, whose company deals "strictly with people who have had credit problems."

Though the industry deals almost exclusively with customers who have a record of not paying bills on time, it still manages to be profitable, dealers say.

"After all, the buyer is not in a position to negotiate on price," writes Jim Rhoads, a consultant who specializes in buy-here, pay-here businesses.

But critics say that consumers with bad credit may end up worse off than they started if they don't strictly adhere to their voluminous contracts.

Ignition Switch as Debt Collector

"If the car is worth $5,000, they're likely to charge you $10,000," said consumer advocate and Atlanta radio host Clark Howard. "If you finance the car at the dealership on top of that, you could be paying as much as 26 percent each year in interest."

Additionally, most dealers place digital "payment reminders" or "starter interrupt" devices in the car that use visual or audio cues to remind the customer to pay his bill, dealers say, or else shut off the car's starter if the customer doesn't make a payment.

On its website, starter interrupt device maker PayTime claims its flagship product "encourages customers with less-than-desirable credit to make their vehicle payments consistently by the due date."

But these devices can be abused, as 100 drivers in Texas found out when a disgruntled former employee of a Texas buy-here pay-here dealership disabled their cars in early 2010, according to newspaper reports.

Some consumer advocates have complained that such a device could interfere in a hospital emergency, and that it is overly intrusive, while defenders say the device is the only reason that subprime consumers are able to get a car in the first place.

"Almost always, the cars are incidental to the purpose of these places," Howard said. "They're in the loan business, not the car business."

Businesses Pile In

And business is good.

About 1,650 National Alliance of Buy Here, Pay Here Dealers, or NABD, met in Las Vegas in May, 15 percent more than in 2009, according to F&I magazine, a financial trade publication that covered the event.

NABD claims 10,000 dealers under its umbrella, with more joining all the time, Shilson said.

In fact, with tighter federal regulations governing loan eligibility, buy-here, pay-here dealerships can often seem like the only option for subprime consumers who need transportation, according to Jim Winsett, president and CEO of the Chattanooga Better Business Bureau.

"If they had an automobile and it's been repossessed or doesn't run any longer, they've got to have transportation to get to work," Winsett said, though he cautions customers to read their contracts carefully and take the car to a mechanic before purchasing it. "If you've got to do it there, try to be as educated in the process as you can."

A Functioning Car as a Mercy

Dealers contend that charging higher interest rates and employing starter-interrupt devices are necessary for consumers with bad credit.

"Without a doubt, we deal with a higher-risk customer than your typical prime, bankable, customer," said Chad Pendergrass, manager of Buy Here Pay Here USA in Cleveland, Tenn.

The high rate of customer defaults, about 33 percent, could be partly due to dealerships like his which allow customers to trade in a car for a newer one, which show up in statistics as loans that were not paid in full, Pendergrass said.

Given the choice between taking public transportation or driving a used car with a high interest rate, subprime consumers should be allowed to make their own decision, said Mickey Dorsey, owner of Friendly Auto Group.

"You can tell if people had a good pay history and then they lost their job, but they always paid well until that point," Dorsey said.

Even responsible people can get stuck with bad credit after a medical emergency or unexpected job loss, he said.

Mike Pryslak, a partner at Chattanooga Motors, agreed that high-risk consumers still deserve a chance to redeem themselves without being forced to walk to work.

"We have customers coming in who, a few years ago, could have bought a car from anybody, but now, credit is tight everywhere," Pryslak said.

But for anyone who can pass a basic credit check, there are often other options to paying twice what a car is worth, according to Bill Weresch, a volunteer at Clark Howard's Consumer Action Center.

"Go to your credit union and get pre-approved before you even set foot in the dealer's place, and show them what you're getting at the credit union as a negotiating tool," Weresch said. He also recommended checking out deals that seem "too good to be true" at the BBB, and taking cars to an independent garage, which most auto dealers will agree to do.

In the end, "It's not about morality, it's about reality," Shilson said. "The higher the risk, the higher the reward needs to be."

E-mail Ellis Smith at esmith@timesfreepress.com, or call him at 423-757-6315, or twitter.com/ellisthered.