How to Start an In-House Financing Business

Offering financing options can be a game-changer for driving higher sales and profits. However, the costs and complexities of setting up financing can deter many small business owners from implementation.

The good news is that modern digital lending platforms make launching customized financing faster, easier and more affordable than ever before.

In this detailed guide, we’ll cover everything you need to know to get your own profitable financing business up and running, including:

• Core financing approaches and industry performance data
• Platform features simplifying operations
• Risk modeling tactics minimizing defaults
• Key metrics guiding growth
• Regulations and compliance factors
• Cost models and profitability analysis

Let’s start by examining popular financing structures.

Types of Retail Financing Options

There are a few main structures for offering customer financing:

1. Traditional Installment Loans

Installment loans distributed directly by retailers make up over 10% of the $630 billion non-mortgage consumer debt market according to TransUnion. Direct loans allow retailers to extend credit for store purchases while retaining ownership of accounts.

On average, installment loan borrowers have the following profile:

• FICO Score: 640
• Average Balance: $2,310
• APR Range: 9.65% – 29.95%

Customers enjoy fixed regular payments while retailers earn reliable interest over multi-year terms. However, underwriting requirements often limit approvals to buyers with higher credit scores.

2. Modern POS Financing

Modern point-of-sale (POS) financing through alternative models has exploded over 300% since 2016. POS lenders now fund over $100 billion in annual transaction volume as of 2021 per Bloomberg’s Krishna Rao. Additional key stats include:

• Average APR: 25%
• Average Term: 11 months
• Top products financed: furniture, electronics, appliances, jewelry
• Average order values financed: $1,500+

Easy applications through integrated POS devices combined with buying power caps based on flexible risk scoring models extending credit to wider applicant pools.

While interest rates run higher, so do approval rates on prime and subprime borrowers. The key to profitability is keeping average balances low (under $2,500) to ensure successful ongoing collections even among riskier consumers. Higher approval rates also drive increased sales volume and larger average tickets.

As discussed later, automated machine learning algorithms dynamically tune scoring models balancing risk to supercharge performance.

3. BNPL Flexible Financing

Buy-Now-Pay-Later (BNPL) financing represents the hottest growing online industry trend. Consumers appreciated segmented fixed payment schedules on online purchases often with zero interest applied. Top BNPL provider transactions grew over 200% YoY as of mid-2021.

The BNPL flexibility allows consumers to purchase today while responsibly budgeting payments over upcoming pay cycles. Merchants pay BNPL providers small interchange fees per transactions that are much lower than credit cards.

With flexible online financing occupying all three financing segments, let‘s analyze the benefits driving retailer adoption.

The Benefits of Offering Retail Financing

Here are the top reasons retailers offer installment financing:

1. Lift Sales Up to 30%

On average, retailers using POS financing or BNPL enjoy 17-30% higher sales compared to cash-only merchants. Easy application and instant approvals empower more customers to confidently make purchases compared to awaiting traditional lending approvals.

2. 44% Higher Average Tickets

Applicants buying on financing spend on average 44% more according to leading POS lender Sezzle. Customers purchase higher priced items, accessories, warranties and value-added offerings when the total cost is spread over 12+ months.

3. Improved Customer Loyalty

Consumers interested in financing often utilization options for multiple purchases. Easy repeat financing drives customer retention for additional sales vs. single-time buyers.

4. Enhanced Brand Positioning

Integrated modernized POS or frictionless BNPL checkout boosts retailer brand positioning over dated manual financing and credit cards alone.

5. New Profit Center

Interest and account fees drive significant added revenue from financing on top of product/service sales. Software fees are nominal compared to profits.

With the benefits clear, how do retailers configure financing operations?

Approaches to Offering Financing

Retailers can enable financing through:

1. Direct Lending

The retailer finances purchases by issuing branded credit agreements themselves. This provides full control of operations, risk standards and profits in exchange for assuming risks.

2. Third-Party Financing Partnerships

The retailer displays financing sourced from a third-party lender at checkout but isn’t involved in account management. Pre-integrations simplify compliance and operations for a per-transaction profit share.

3. White Label Platform Solutions

White-label platforms provide an agile middle option to launch customized programs. The retailer issues branded financing, primarily manages relationships while the platform assumes most software and administrative processes for a % of interest.

These options make it simple to tailor financing strategies to business needs and risk appetites using flexible software.

SaaS Financing Platform Capabilities

Modern software-as-a-service (SaaS) solutions transform financing processes through automation and digitization. Platform features include:

Platforms streamline underwriting, contracting through to account management while offering native integrations to complementary systems for data flows and seamless user experiences:

Now that we‘ve covered approaches and platform features, let‘s explore risk management techniques to minimize losses.

Risk Management Guidelines

No financing program comes without risk of delinquencies and defaults. However, calculated risk standards can help minimize losses from non-payments. Here are research-backed tactics for reducing risk when financing purchases:

5% Minimum Down Payments

Requiring 5-10% minimum down payments gives customers “skin in the game" while ensuring adequate equity exists if items must be reclaimed and resold upon default.

Custom Risk Scorecards

Using 50+ weighted application data points in custom models is key for approval decisioning. Scorecards centralize applicant factors from identities to credit history to income levels predictive of default probabilities.

Scorecard examples may include:

Custom scoring balances automated decisioning against risk standards like 70+ score minimums having 67% application approval rates but just 4.1% 60-day late cyclical rates once implemented.

Capped Lines & Balances

Limiting initial credit lines at under $1,000 and capping total balances under $2,500 controls risk exposure to individual consumers. Reasonable limits keep payments affordable based on income ratios to prevent snowballing bad debt.

Dynamic Line Management

Software algorithms dynamically tune revolving limits higher or lower with eligible repeat applicants based on payment performance trends. Lines tightening contain exposure when emerging late payments indicate affordability issues.

72 Hour Right of Rescission

Mandated waiting periods provide a customer “cool off” window to cancel financing without penalty. This reduces pressure buying while giving transparent inspections for returns if quality issues appear.

Daily Default Probability Forecasting

Software projects portfolio-wide probable loss rates by statistically analyzing the intersection of economic inputs, portfolio performance metrics in the context of custom bad debt models. Models tuned monthly best indicate emerging trouble often 6-9 months sooner than lagging scorecards.

Let‘s examine how data-driven analysis sustains growth.

Key Financing Metrics Guiding Decisions

Centralized reporting dashboards track essential financing metrics enabling data-driven management:

Let‘s examine two metrics powering growth.

Utilization Rates

The ideal portfolio range falls between 40-60% showing holders regularly utilize available credit while preventing excessive risk exposures. Declines below 40% indicate conservative under-borrowing while rates above 80% signal potential trouble managing payments.

Optimizing periodic credit line increases responsibly pushes utilization into peak brackets for account profitability. This is accomplished by monitoring income and existing balances before automatic graduated boosts improving holder purchasing power.

Risk Pool Mix

Balancing subprime, prime and super prime risk pools ensures economic durability. As prime buyers represent significant yet stagnant addressable market share, structured risk-based offerings responsibly capture high-value subprime consumers at sufficient scale to positively impact sales volumes without distorting losses.

This data shows the exponential revenue potential from digital financing with analytics tightly guiding operations. Now let‘s explore required regulatory licensing.

State Lending Regulations

If providing direct financing or loans, state licenses for lending activities are required. All states regulate interest rates plus set operational requirements although specifics and costs vary widely.

For example, caps range considerably:

Licensing ensures financing business and disclosure practices align to state laws protecting consumers. Failing to acquire mandated lending licenses risks significant State Department fines up to hundreds of thousands in penalties per offense.

Compliance management tools track disclosure statements and e-signature consent to approve financing products balancing growth against regulator obligations. Documentation should be saved for similar periods matching applicable statutes of limitations.

Now that we have covered regulations, let’s explore operational costs.

Financing Business Cost Considerations

Common financing operation costs include:

Software & Infrastructure

Cloud-based software reduces infrastructure needs with monthly platform subscriptions generally starting under $500 per month. Enterprise-grade redundancy ensures uptime supporting lending functions across high application volumes.

Expansion Liquidity

Unless exclusively partnering for financing capital, retailers should secure expansion operating lines of credit granting required funds to finance purchase values in aggregate prior to incoming payments. Typical APRs on lines run from 4 – 12%.

Risk Reserves

A reserve pool should be allocated to write down a portion of non-performing receivables from the small subset of unrecoverable defaults. 5% of origination value earmarked can offset bad debt costs through tax benefit accounting. Reserves scale as portfolios grow.

Internal Payroll

Staff will be required to manage underwriting processes and account management such as document collection, applicant communication and customer service. Consider 1 FTE for every 5,000+ open accounts. Existing teams can absorb subsets of financing administration initially.

Professional Services

Specialists help retailers launch and subsequently optimize financing performance through services like risk model tuning, HMDA auditing and regulatory guidance. Expect one-time and monthly consulting fees.

Partner Commissions

When leveraging third-party lender relationships, partner commissions represent cost sharing on financing revenue for the life of funded accounts. This compensates partners for marketing, capital and infrastructure.

Now let’s examine the profit equation.

Financing Business Revenue Drivers

Key financing revenue sources include:

Interest Income

Interest accumulated on principal as borrowers make payments is recorded as direct revenue. Optimal portfolio rates averaging 28% yield significant gains off $5,000 at 36 month terms. Declining receivables balance as principal owed reduces mean sizable upfront revenue recognition as balances remain outstanding.

Interchange Fees

When integrating with payment networks like VISA to process transactions, small interchange fees apply on all financed payment volume contributing added revenue.

Account Fees

Common direct fees boost profits through application fees, late fees, returned payment fees and prepayment penalties for early payoffs limiting interest accumulation.

Merchant Discounts

For retailers in distribution channels, interchange fees paid by partner merchants provide revenue shares on their transactions where financing was funded.

Let’s examine how financing revenue growth fuels break-even timeframes.

Financing ROMI & Breakeven Pacing

Software costs are nominal compared to long-tail revenue from ongoing account interest and fees. Most programs fund all technology and operating expenses within 90 days of launch through portfolio proceeds.

For example, consider a mid-size retailer approves $350K in financing per month around 28% APR at 36 month terms:

• Monthly Revenue: $98K
• Monthly Expenses: $12K
• Monthly Net: $86K

Breakeven hits quickly within the first two months with substantial added margins beyond covering operational costs at scale.

Determining if launching financing aligns to business objectives requires comparing the profit upside to organizational appetites managing risk, compliance and software. For qualified retailers, partnering with an expert FinTech provider simplifies operations for sustainable gains.

Now let’s summarize key takeaways for financing success.

Summary: Keys to Financing Business Success

Here are best practices to launch and grow profitable financing:

• Start with pre-built templates and partner integrations
• Limit risks with automated decisioning workflows
• Scale approval rates through precision tuning
• Focus staff on customer management
• Keep average balances under $2,500
• Maintain 60 day late rates under 6%
• Structure diverse risk pools balancing segments
• Monitor portfolio metrics guiding optimizations

Ready to accelerate sales and retention with strategic financing? CompassWay offers secure digital lending platforms helping retailers master frictionless programs.

Get Started with launching personalized installment financing in just days!