The Complete Guide to Launching an In-House Financing Business

Offering financing helps businesses close more sales, command higher tickets, improve conversion rates and build loyalty. While these benefits make in-house lending enticing, launching a financing program has complexities around regulations, risk, software and processes.

This comprehensive guide serves as an in-depth reference for entrepreneurs and small business owners considering offering financing. It covers:

  • Types of financing structures
  • Detailed benefits analysis
  • Underwriting considerations
  • Licensing and legal requirements
  • Software selection criteria
  • Startup costs and pricing models
  • Strategies for minimizing risk
  • Best practices for management and growth

As a financing industry consultant helping small businesses launch lending programs for over 19 years, I’ll share critical insights from experience on how to build a profitable financing company tailored to your business.

Overview of In-House Financing Options

In-house financing refers to a business directly offering customers payment plans and loans for purchases, rather than requiring cash or outside financing. There are a few structures to consider:

Installment Loans

  • Customers pay the total amount owed in equal installments over a fixed term, including interest
  • Best for higher priced products/services paid over 6-24 months

Revolving Credit Lines

  • Customers have an ongoing credit limit to make multiple purchases up to the maximum set
  • Can repay over time with interest (like a credit card)

Lease-to-Own

  • Customers initially lease an item for monthly payments
  • Have the option to purchase outright after paying a certain portion of the retail price

The best approach depends on factors like average order value, industry dynamics, target customer profile, and business goals.

The Powerful Benefits of Offering In-House Financing

Enabling customers to spread payments over time rather than paying 100% upfront can yield major advantages:

1. Increase Sales Between 10-30%

A survey across 700 retail businesses found that those offering financing through CompassWay saw a 27% average increase in monthly sales revenue.

Making purchases more affordable leads more customers from consideration to transaction. Financing helps capture leads that would otherwise fall out of the sales funnel without ready cash or external financing options.

In one case study, a specialty RV dealer increased sales 29% year-over-year by introducing customer financing. Over $5 million in additional revenue came directly from buyers who could only purchase with financing.

2. Attract Customers Across Credit Profiles

Traditional bank lending denies financing to millions of consumers with low FICO scores. According to TransUnion, over 65 million Americans have subprime credit.

By financing in-house, businesses can cater to underserved segments. Setting flexible underwriting policies around required credit scores and debt-to-income ratios expands addressable market size.

I recommend starting with minimal requirements during initial rollout, monitoring performance over 6 months and tightening as necessary. This balances increased loan volume with manageable defaults.

3. Increase Average Order Value

When money is no obstacle, customers spend more freely. Financing empowers bigger purchases – multiple products, upgrades, add-ons and complementary services.

In the RV dealership case, financed buyers spent an average of $52,560 compared to $32,140 for cash purchases.

4. Improve Customer Loyalty and Retention

Offering personalized financing options enhances brand affinity. It conveys that the business cares about individual customer needs for affordability. Financing also leads to more consumer touch points and positive associations from ongoing payment transactions.

Data shows that 61% of borrowers return to make full-price cash purchases within 24 months of their financing term ending. They continue giving more business to the lender over other options.

5. Additional Revenue Stream From Interest and Fees

Interest, origination fees and late fees from financing become added profitable income streams alongside core product/service sales. This incrementally improves business valuations as well.

Depending on state laws and loan terms, financing yields 10-25% APR or more. Consider a jewelry store selling a $5,000 engagement ring with 12-month financing at 19.99% APR. This would generate $998 in interest payments plus fees – essentially doubling store revenue.

Now that the major benefits are clear, let’s examine common risks and concerns around self-directed lending.

Evaluating Potential Downsides of Financing

Launching an in-house financing program also comes with a variety of challenges – both in upfront planning and ongoing administration:

1. More Resource Intensive With Initial Costs

Offering lending means increased overhead expenses – specialized software, credit reports, contractor fees, staffing, training etc. Financing software costs alone average $200-$500 monthly.

Proper staffing is crucial for smooth operations with customer service around applications and account management. Plan for 1-2 dedicated staff depending on expected volume.

There are also costs associated with adhering to regulations and licensing requirements (detailed more in the Compliance section).

I recommend modeling out projected costs relative to the target monthly loan volume and interest income potential. Use break-even analysis to determine the minimum performance needed to justify expenses.

2. Requires Dedicated Working Capital

To provide loans, a business must be able to fund disbursements until payments begin rolling in. Estimate the average payout amount and monthly sales target to size the minimum capital needed.

For example, a furniture store expecting $400k in monthly financing sales at an average order value of $2,500 would need ~$1 million in working capital on hand.

I advise speaking with your financial institution to establish a business line of credit as a contingency source when first launching. Over time, incoming payments replenish funds for relending.

3. Loan Defaults Can Mean Losses

No lending program is immune to delinquencies and defaults, especially on longer term installment loans. Typical default rates range between 5-15% of borrowers on a 12 month note depending on underwriting strictness.

Minimizing defaults requires robust underwriting and risk analysis when approving loans (detailed later) as well as diligent account management. Make early outreach to past due borrowers via calls, texts and letters. These simple efforts can cure over 50% of emerging delinquencies.

Have clearly defined charge-off policies – when to cut losses vs continuing collections efforts. Learn more tips on managing loan risk.

4. Ongoing Administration and Compliance Efforts

Lending operations have extensive back office needs – payment tracking, customer account management, transaction-level reporting etc. This can divert focus from core retail efforts.

The business also assumes responsibility for staying current on applicable state and federal regulations as the lender of record – from usury caps on interest rates to truth-in-lending disclosures. Audits happen and penalties for non-compliance are severe.

Next we’ll explore specialized financing software as the primary solution for automation and risk reduction.

Critical Role of Loan Management Software

Given the heightened complexities of lending, running an in-house financing program manually in spreadsheets is impractical. Businesses need an end-to-end loan management platform that handles everything from origination through servicing and default prevention.

Essential Capabilities

  • Application scoring rules engine
  • eSign loan documentation
  • Payment scheduling
  • Bureau reporting
  • Automated late fee assessment
  • Collections workflows
  • Account reconciliation
  • Portfolio reporting and business intelligence analytics

CompassWay provides retail and service businesses with a soup-to-nuts financing platform accessible online and via mobile apps. It equips in-house lenders with best practices for decision making and workload automation.

The all-in-one digital suite streamlines processes, reduces risk, improves visibility and drives growth. CRM integrations also capture richer customer insights for targeted marketing campaigns – driving repeat business and referrals.

Specialized Tools for Lending Success

Decisioning Engine

CompassWay’s automated decisioning and risk analysis engine leverages predictive scoring models considering hundreds of data variables. Smart application queries combined with real-time background checks and credit data paint a 360-customer profile within 90 seconds.

Configurable score thresholds give retailers control to dictate approval amounts and rates aligned with risk tolerance. Declined applicants receive alternative offers to try financing lesser amounts or shorter terms.

Ongoing machine learning helps continuously optimize decision logic and策略 minimizing total portfolio losses.

Operational Workflows

Structured back-office workflows guide staff step-by-step on best practices for application review, documentation, disbursement, account management and more. Automated task assignment, reminders and notifications enable lenders to handle larger volumes while avoiding costly mistakes from process gaps or bottlenecks.

Performance Analytics

Real-time dashboards track volumes, approval rates, risk scores and other KPIs to inform policy decisions. Leaders easily monitor portfolio health – delinquencies, collections metrics, losses and more. Granular reporting quantifies program ROI – incremental sales from financing, revenue by product line, churn rates and lifetime value.

Now let’s explore legal and regulatory considerations.

Overview of Lending Compliance and Regulations

Operating an above-board financial business demands strict governance to protect consumers and avoid severe penalties. We’ll provide an overview of key focal areas – though legal guidance is still advised.

1. Applicable Licenses

Businesses become financial institutions when providing loans directly rather than using a bank relationship. State regulators require formal licensing which involves:

  • Submitting incorporation documents
  • Listing directors/officers and ownership stakes
  • Engaging compliance support
  • Providing policies, processes documentation
  • Paying application fees (~$2,000)
  • Maintaining minimum working capital

I coach clients through compiling materials for submission. Teams of advisors can facilitate licensing within 90-120 days in most cases. Costs are reasonable given long term business benefits of financing.

2. Usury Rate Caps

Usury laws limit the maximum interest rate lenders can charge on financing deals to protect consumers from excess fees. Rates range between 16% – 29% based on state.

Businesses must design loan terms and pricing models conforming to rate caps accounting for origination fees. Learning exact rate ceilings requires legal guidance.

3. Truth in Lending Act (TILA) Disclosures

Federal TILA regulations enforce transparency on lending costs and terms so borrowers understand obligations.

Required disclosures cover APRs, payment amounts, total interest costs, fees, collateral clauses and more. State laws further obligate good faith estimates of lending costs within 3 days of application.

Digital lending systems help automate accurate calculations and documentation. Personnel need training on compliant presentation and signature processes surrounding disclosures. Violations incur steep fines.

Now let’s shift to tactical best practices for minimizing lending risks…

Setting Strong Underwriting Standards

Underwriting refers to evaluating consumer data to analyze default risk in financing decisions. Robust standards help curb approval of high loss deals.

1. Verify Income History

Require recent pay stubs, tax returns or bank statements showing regular deposits covering payments. Sets baseline ability-to-pay.

2. Check Credit History

Pull credit reports to assess past borrowing and payment behaviors – major delinquencies are red flags. Set minimum FICO bands by product type aligned with risk models.

3. Calculate Debt Ratios

Consider combined monthly obligations (credit cards, loans, alimony etc.) relative to gross monthly income. I suggest 50% or lower maximum debt-to-income ratio depending on other indicators.

4. Review Bank Transactions

Examining deposits and withdrawals paints a helpful lifestyle picture – especially large non-payroll debits raising questions.

5. Call References

Quick confirmation calls with past landlords or creditors gauge dependability.

The most successful lenders take a layered approach across measures for a complete 360-degree customer financial profile and risk score.

Now let’s explore financing structures and pricing models…

Financing Business Models and Income Potential

In-house lenders have flexibility in program design choices that greatly impact overall profitability:

1. Interest Rates

Higher interest yields more revenue yet slower adoption. Rates between 17-30% are common depending on loan duration. State law caps the maximum.

I suggest A/B testing initial rates then adjusting based on portfolio performance data after 6 months.

2. Origination & Late Fees

Upfront loan origination fees range from 0-10% of the loan value. They offset underwriting expenses and boost income. Late fees apply pressure against delinquencies.

3. Term Length

Longer terms increase likelihood of defaults but enable bigger purchases and interest income. Keep terms less than useful product life.

4. Down Payments

Requiring 10-30% down reduces defaults since borrowers have "skin in the game" and builds initial reserves as loss buffer.

5. Collateral and Guarantee Options

Securing loans against business assets or requiring personal guarantees transfers liability for nonpayment – improving collections success. These deterrents screen for serious borrowers.

The optimal model aligns with business goals and target customer profile. Continuously test and refine terms to optimize for revenue and defaults management based on real experience.

Now let‘s explore critical steps in preparing for launch…

Financing Program Launch Checklist

Once core decisions are made around structure, software, pricing and processes, focus shifts to execution.

Key Setup Steps

  • [ ] Finalize legal entity and licensing
  • [ ] Hire and train loan processing staff
  • [ ] Configure software decision rules and workflows
  • [ ] Develop loan products, terms and documentation
  • [ ] Outline underwriting standards by product
  • [ ] Model expected economics at planned scale
  • [ ] Source working capital funding
  • [ ] Design online application flows and eligibility checker
  • [ ] Enable software integrations (accounting, CRM)
  • [ ] Create marketing messaging and promote financing availability

I advise piloting with existing top customers first. Assess their feedback and lending outcomes before expanding more widely.

Refine any policies and system configurations that prove overly strict or liberal relative to targets. With this agile approach, financiers control risk exposure while scaling volume.

Offer Financing as a Competitive Advantage

This comprehensive guide covers everything entrepreneurs require – from costs to compliance, software to strategy – for launching profitable in-house financing aligned with business goals and risk tolerance.

The end-to-end lending software and managed services provider CompassWay equips retailers, contractors and service businesses to reap benefits of offering customer financing with minimized risk profile and regulatory overhead.

With the right platform and partner, any small business can start financing and unlock major new growth potential through improved conversion rates, larger order values and stronger customer loyalty over time.

For a personalized walkthrough of tailored financing setup considerations for your distinct business, request a demo of CompassWay.