If you’re shopping for a used car, you’ve almost certainly heard of CarMax. They are, by far, the biggest company in the used car industry, and as a result, they’re one of the largest sources of used car financing as well. But CarMax, despite being more open to bad credit or “subprime” loans than it has in the past, has made it clear that there’s only so far they’re willing to go when it comes to subprime lending.
Risk And Reward
Subprime, in the auto industry, just means “bad credit.” And it’s a sector that, while small, has been growing as the economy improves and more people find themselves with a need for a car. As a result, CarMax has been experimenting with subprime loans, offering a test program beginning in 2014 to offer subprime loans through its financing arm, CarMax Auto Finance.
The program was arguably a success. Despite limiting the subprime loans issued to just 2% of all loan originations, it still grossed $72.2 million in loan originations in one year. And the rising demand for subprime loans would seem to be priming CarMax to accept even more business directly from consumers. So why is the nation’s biggest used car dealer shying away from a sector so many others are embracing?
The short answer is that they aren’t making quite as much money as you might think. CarMax Auto Finance isn’t really a financing bank in the traditional sense. It’s what’s referred to as an “indirect” lender in the auto industry, where it finds you a lender and take a small piece of the loan as an origination fee.
However, even if you just had one bad year, and are cleaning up your credit score, you still are technically more of a risk than someone who isn’t dealing with financial problems, and so CarMax needs to offer incentives to those lenders. According to other reports, that generally works out to $1000 per loan.
Furthermore, indirect financing is coming under increasing scrutiny by federal and state authorities. While CarMax itself has avoided any of the more unethical behaviors the government is concerned about, California is working to do away with indirect lending altogether, a movement that’s starting with a voluntary program but that many expect will end with legislation.
Finally, CarMax may simply believe that its customers are better off securing direct financing. Unlike some used car dealerships, CarMax primarily makes money by selling cars, not selling the loan you take out to buy the car. Direct financing, where you contact the lender yourself and secure the loan without a dealer being involved, is generally better for both the consumer and the dealer: The consumer gets lower rates and has their choice of lender and term, while the dealer has less paperwork and a quicker route to selling their customers cars.
In other words, if you have bad credit and are shopping for a used car, it’s best to contact lenders directly. That way, you know you can afford your car.