The Two Sides of Financing: Commercial and Consumer Lending Compared

Commercial customers financing their first business purchase are often shocked.

Financing for business vehicles and equipment is *much* different than financing a car or a sofa.

Rob and Jenn break down the complex worlds of consumer and commercial financing in a way that’s easy to understand.

Transcript

Rob 00;00;05;24 - 00;00;09;25

Welcome back to the Smarter Business Finance Podcast. I'm Rob Misheloff.

Jenn 00;00;09;25 - 00;00;11;12

And I am Jennifer Casey.

Rob 00;00;11;22 - 00;00;41;08

And today we're going to talk about the difference between consumer financing and commercial financing. So one of the things that is underestimated in life and in business in general is the cost of things. We don't really see like risk. And in fact, in the business world, there's a lot of things that carry more risk than they do in the consumer world.

Rob 00;00;41;20 - 00;01;16;03

And we know that because prices are higher in the financial markets, for instance, the insurance market, it costs us to have essentially what is renters insurance, insuring our office and so forth. It's between or we have with two small offices. And those offices cost a total of $300 a month to insure versus when I was a young adult and I got renters insurance on my apartment, it cost almost nothing.

Rob 00;01;16;03 - 00;01;17;08

It was $32.

Jenn 00;01;17;08 - 00;01;22;12

I was going to say, yeah, I think mine was $30. And I my homeowner's insurance is a lot more than that.

Rob 00;01;22;19 - 00;01;42;25

Yeah, exactly. Yeah, but businesses carry more liability. They carry more risk. And so the costs are higher. And I know we were talking earlier about the cost to insure a car for a consumer versus if you're doing it for a business.

Jenn 00;01;42;25 - 00;02;04;14

Right, For example, a consumer to insure a vehicle is a lot less versus a commercial business. We have that all the time where we have, let's say a sole proprietor has been on their own insurance and the vehicle is registered under themselves. And then they realize that they need a commercial policy because they're now making this this side hustle an actual business.

Jenn 00;02;05;13 - 00;02;24;04

They are very, very shocked over the cost. Once they upgrade to a commercial policy. They're also very shocked over the type of limits that they need to have because you are more susceptible to people suing you like you're saying, a higher risk. It just it costs more to do business versus to be a consumer.

Rob 00;02;25;11 - 00;02;35;17

Right. Like my personal car costs about $100 a month to insure. But if I was to go get a tow truck, depending on what state I'm in, it could be $800 a month or more. Right.

Jenn 00;02;36;05 - 00;02;36;12

Right.

Rob 00;02;37;06 - 00;02;59;14

So that plays in well to what we're going to talk about, which is why commercial financing costs more than consumer financing. And a lot of times our customers are pretty surprised because the rate that they expect is far different than the payments. They end up actually getting. Right?

Jenn 00;02;59;15 - 00;03;21;00

Exactly. Yeah. One of the things that we were chatting about the other day was really it does come down to risk when you think about a consumer financing a vehicle. You know, I think about my first vehicle that I financed, which I did not finance a car when I was 18. I was when I was probably in my mid-twenties, but still when I when I purchased that vehicle, I kept that vehicle for years, several years.

Jenn 00;03;21;00 - 00;03;42;08

And most consumers keep vehicles for several years. Or if they're giving it back to the dealership, they're getting another one. It's that's a very low risk to finance someone's vehicle. There's not a lot of default with that. And if there is a lot of default or if the person has, you know, less than attractive credit, they're going to get a way higher rate on it because the risk is higher.

Jenn 00;03;42;08 - 00;03;58;09

But when it comes to a business, businesses don't keep their vehicles as long as a consumer does. Why they're upgrading or they're expanding or they're defaulting, they're closing their business. So that's a risk that that lender then takes on a regular basis.

Rob 00;03;58;10 - 00;04;25;19

Okay. Let's dive into that a little bit more, because it's almost hard to see how much more risky it is for a business to finance a vehicle than a consumer. But if you think about it, if I'm a parent and I don't have a car, I can't take my kids to school, I can't go to work. But if my business shuts down, I don't have any more need for a dump truck or a tow truck or anything like that.

Rob 00;04;25;29 - 00;04;56;08

And of course, I'm going to stop paying on it. And if I repossess a Honda Civic, there is somebody within three blocks that's going to want to buy that Honda Civic. If I repossess a Kenworth dump truck, I have to find somebody that wants to buy a Kenworth dump truck and that applicant pool is much, much smaller. And so it's going to be more difficult to unload that particular piece of equipment.

Rob 00;04;56;08 - 00;05;11;23

And a large percentage of defaults are due to breakdowns. Once that vehicle is repossessed, there's a high probability that it's broken and is no longer going to have the value it had on paper.

Jenn 00;05;11;24 - 00;05;27;02

So you bring up a good point. You know, you have to think with a commercial dump truck, you're generating revenue, right? You're making money off that. Sure. You're hauling rocks, you're hauling gravel, you're hauling something. What do you hauling in your Honda Civic? Nothing.

Rob 00;05;28;04 - 00;05;29;01

A gym bag.

Jenn 00;05;29;05 - 00;05;29;15

Right.

Rob 00;05;29;15 - 00;05;30;08

Some water.

Jenn 00;05;30;08 - 00;05;52;06

Right. And in order for you to just live your life, you have to drive that vehicle. And most of the time as a consumer vehicle, you're driving that thing during the week, at night and weekends for commercial vehicle. It's really for that company to make business. So the chances that you're going to not make money while having a vehicle for your business is slim to none.

Jenn 00;05;52;06 - 00;06;02;00

I mean, the the majority of our lenders, I would even say 95% of our lenders won't finance anything unless it's actually revenue generating. So something to think about.

Rob 00;06;02;03 - 00;06;38;27

Yeah, but you made a good point in there because the hauling rocks, right. That the typical dump truck has several tons of dirt or rock in it and it's going to be highly likely to have some maintenance issues and the lender has to factor in the risk that if the borrower cannot pay to have it fixed and whether it's a dump truck or, for example, a semi truck, that maybe it's going out into the oil fields and it's not driving on the road, it's driving over all sorts of things that's going to break that bottom.

Rob 00;06;38;27 - 00;07;18;01

If it's not the correct type of vehicle or they don't have the undercarriage properly set up or it's a drill truck that's literally breaking the earth, you are going to have breakdowns. And a lot of times we find we come across folks that are buying a 50, 60, $80,000 piece of equipment and they don't have 10,000, $20,000 set aside in reserves just for repairs and many businesses and banks know this and lenders know this.

Rob 00;07;18;16 - 00;08;09;10

Many businesses are a breakdown away from bankruptcy. And that has to factor in to pricing of payments on commercial equipment. Because, remember, it's not just your own risk you're paying for. The lender only sees you as a pool of applicants. In fact, it's called a static pool. And they know that based on certain criteria, the risk of not getting paid is X amount, and a computer tells them that much and they have to factor in their costs to get the money to you, meaning the cost to borrow the money, their cost to do the paperwork, and then their cost taking into account how many applicants out of 100 historically are not going to pay them

Rob 00;08;09;10 - 00;08;18;12

back. And they have to figure out what payment to charge to encompass that risk and still make a profit. Because without profit.

Jenn 00;08;19;11 - 00;08;44;25

America starts. Right? Right. And the majority of small business owners are very small. So it does. The 8020 rule is definitely the 8020 rule in regards to small businesses. 80% of companies out there are making 20% of the money. And again, 20% of the businesses are making 80%. So of that amount, I mean, the majority of our clients that are even that we're talking to have under five employees.

Jenn 00;08;45;05 - 00;09;01;22

So if you have a vehicle that you're making a payment on on a monthly basis and that employee is no longer with you, I mean, the even finding a good employee is pretty hard to find. So if you don't have that revenue coming in on that vehicle, now, there's a chance of you not making that payment that month.

Jenn 00;09;01;22 - 00;09;24;01

So one of the things about that we talk about with risk is the risk goes down when that company gets larger, Right? Right. They have five vehicles. They have ten vehicles. They have 20 vehicles. You know, that's part of the credit factor that we look at. And it's a lot more attractive to a lender. When you have a staff of 50 people, someone's going to pick up, pick up the ball and keep running with it.

Jenn 00;09;24;01 - 00;09;41;10

Someone is going to grab that truck or the other vehicles are making up for that revenue that's lost with that versus if you have only two or three trucks, that's a huge hit. If that employee isn't coming to work, let's say that they get sick and they're out of work for two weeks with the flu or three weeks, that's revenue for an entire month that they're out at that point.

Rob 00;09;41;10 - 00;09;43;04

So COVID can get pretty expensive.

Jenn 00;09;43;04 - 00;09;44;12

Yes, very high risk.

Rob 00;09;44;28 - 00;10;17;02

So let's talk about that risk and what it actually looks like getting granular, getting into the real nitty gritty, because I'll give you an example for car lending to the general public, to just consumers typically be the default rate overall or the number of people that don't pay for their cars is 2% or less. In fact, any time it approaches 5%, that makes it into every newspaper because it means we're in a big recession, the whole world's falling apart.

Rob 00;10;17;10 - 00;10;56;12

People can't pay for their cars in commercial lending, a 5% default rate. It means it's Wednesday, right? It really does. And in fact, it depends on the portfolio because depending on the business profile, default rates can get pretty high. And I'll give you an example. We have a lender that we work with that does very challenged credit deals that the some of the highest risk deals that we do and that lender did a site visit to see our operation and see if we were somebody that they really felt comfortable sending them business.

Rob 00;10;56;23 - 00;11;18;02

And one of the things that was brought up during that conversation was, well, you guys have a 24% default rate and we almost fell out of our chairs, right? We couldn't believe that it was that high. And she looked at us and she said, no, that's pretty good for for this tier, for this credit tier.

Jenn 00;11;18;05 - 00;11;19;05

Right.

Rob 00;11;19;05 - 00;11;42;04

That's lower than what we expect. We typically see around 30%. Why do you think our rates are so high? Did you think we were greedy? No, we're trying to run a business here. So, in fact, again, it's not that anyone's out to get you most of the time. Sometimes they are, but in general, you should shop around. Absolutely.

Rob 00;11;42;04 - 00;12;06;29

Shop around and see if you can get a legitimate better deal if you get a lousy approval. But more often than not, when you get an approval that looks really yucky, looks really icky, and you don't know how it could possibly be that high, it's just the actual risk of the transaction. And it's not some guy in the back saying he doesn't like the way you look on your driver's license.

Rob 00;12;06;29 - 00;12;29;09

It's numbers. It's based on this amount of time in business, based on this industry, based on this type of equipment and based on this credit profile. What does the previous pool of applicants look like and what numbers does that lender have to charge in order to keep being a lender next year and the year after?

Jenn 00;12;29;09 - 00;12;48;04

Right. Right. And it's one of the things that I do tell our account managers is that keep in mind that every quarter a lot of our lenders review their transactions and they look at who didn't pay, why they didn't pay, and they look back at the credit portfolio and when it was originally submitted, what it looked like, What did that credit look like?

Jenn 00;12;48;04 - 00;13;06;07

So if someone has a credit profile that fits all of these delinquencies, they will then start re scoring the deals moving forward on a quarterly basis. So I know, for instance, I was looking at a deal this morning and one of our reps was just shocked. He's like, I can't believe that this client got this approval. I'm so bummed.

Jenn 00;13;06;16 - 00;13;33;19

I want to go back. And I think we should ask for a, you know, a better payment for them. And I said, Well, let me take a peek at it. And I said, okay, you are not you're only seeing one thing on here. You're only seeing the score when in reality the client had $140,000 in installment loans and only two years time a business was financing everything on his personal self, nothing on the commercial.

Jenn 00;13;33;26 - 00;13;51;10

So they're looking at that saying this gentleman is, you know, running this business with six figures worth of of installment loans, of debt, you know, And that rep was like, well, he's got no credit card debt. He's got no this, no that. But at the end of the day, that ends up being a very high risk if anything was to happen to that client.

Jenn 00;13;51;17 - 00;14;08;08

It's on their personal credit and they're carrying six figures. I was actually very impressed that the lender even gave the client an approval. I said, Do we have bank statements on filed with anything to show good cash flow to make the transaction stronger? And he said, no. I'm like, that might be a good thing to see that way the bank will feel a lot more comfortable about the situation.

Jenn 00;14;08;08 - 00;14;23;27

So I do think it's the nitty gritty about, you know, these banks are getting very granular on how they are approving transactions in general. So it's just something to keep in mind. But absolutely, the risk goes up significantly when it comes to businesses versus consumer.

Rob 00;14;23;28 - 00;14;46;01

Yeah. And on a personal note, getting this business off the ground, I went six figures into personal debt and I was this close to bankruptcy. Having a profile like that, even if you have a good score, because I had a good score too. But I was this close to filing bankruptcy, and when I was that close, no one was going to give me any more money.

Rob 00;14;46;09 - 00;14;49;28

And anyone who gave me money at that point would have been crazy.

Jenn 00;14;50;04 - 00;15;17;20

Right? Right. And I tell people that and I also tell our clients that when they come back to us and they're like, well, I bought after my second transaction or third transaction because I have a pay history now I'm going to get a better deal. And I said, Well, yeah, but it also now the risk goes up if you haven't been paying on it for long enough, now they're just seeing that you're taking out all this debt, but you haven't necessarily addressed the debt that you have if you're making revenue, why don't you pay down a few things that way?

Jenn 00;15;17;20 - 00;15;37;02

You don't look so overleveraged at that point. You know, the biggest thing is obviously cash is king and business. Hang on to it as much as you possibly can, but also try and pay off some of the items that you have, at least in the first 12 to 24 months or take a shorter term before you're coming back and asking for an additional 200, 300, 400,000.

Jenn 00;15;37;09 - 00;15;53;21

Again, it can be it can be very risky. I would say live conservatively when you're first trying. One of the things actually, Jackson and I were talking about this on a recent podcast as well. Give us your end all be all list and then let's go through and let's rank that. What is the most important piece of equipment on here?

Jenn 00;15;53;21 - 00;16;09;09

What's the second most important piece of equipment and your third and your fourth and what have you? Let's try and get this number one for right now. Let that make you some money and then maybe get that second one and then maybe get that third one. So it's definitely just a different way to try and run your business as well.

Jenn 00;16;09;09 - 00;16;20;16

And lenders appreciate that. They really do appreciate clients that are a little bit more conservative when they're when they're coming out the gates, at least in their first year, excuse me, first five years of running their business.

Rob 00;16;20;22 - 00;16;55;15

Yeah. And I'm going to add something because I don't think and I know we've mentioned it on prior episodes, but I don't think it can be stressed enough that one of the differences between consumer and commercial financing is not just that commercial financing in general costs more and that that can be a surprise. But so on the consumer side, most of the times, unless unless you're financing a home or an education, you're not financing something that's going to make you money.

Rob 00;16;56;03 - 00;17;23;25

Right. And so on the commercial side, you get the best deal you can reasonably get, but you don't do too much crying that the payment isn't exactly what you thought it was going to be. If the payments a couple hundred dollars more than what you had planned for. If that couple hundred dollars makes a difference in your PNL and your profit and loss statement, like a significant difference, you don't have a good business, right?

Rob 00;17;24;01 - 00;17;38;26

If and one of the examples I use most often is dump trucks. The reason why I use that is because it's one of the easier businesses in terms of not that not that it's easy to run a dump truck business.

Jenn 00;17;38;28 - 00;17;41;13

It's easy to understand.

Rob 00;17;41;13 - 00;18;11;29

It's easier to understand the you can draw a straight line from the loads they haul to the profit, and most have the same numbers. And so and for example and I know it's gone up because the fuel prices have gone up and for some other reasons, but in general, all over the past ten years, if you talk to 100 dump truck owners and say, what are you going to get paid for using the dump truck, assuming like a tri axle dump truck.

Rob 00;18;11;29 - 00;18;37;23

Right. They're going to be making on the revenue side about $85 an hour. Right. And if you're running it 50 hours a week, some are going to be less. Some are going to be more. But we just call it 50 hours a week. The number shake out that you're going to see about $18,000 a month in revenue. And then there are going to be costs and those costs are going to be fuel four grand a month.

Rob 00;18;37;23 - 00;19;01;22

So we're at $14,000 a month. They're going to have insurance that's going to be $1,000 a month. Now we're at $13,000 a month. They're going to want to set aside a thousand bucks a month for maintenance. So now we're at $12,000 a month and you take away the payment and that's about the profit. Right? So let's say they were expecting a 1500 dollar payment, which would give them $10,500 a month.

Rob 0;19;01;28 - 00;19;24;22

And they get really shocked. They end up with a $2,000 payment. That's not a bad day at all. And if you are driving somebody else's dump truck, making four or $5,000 a month and you can double that in that income, which by and large is what we see happen. This is not fairy tales. This is what we see every single day.

Jenn 00;19;24;23 - 00;19;25;22

Regular basis. Yeah.

Rob 00;19;26;00 - 00;19;55;06

Right. The payment just doesn't matter. And I have not in the entire time we've been in business and we've done I don't know how many thousand transactions. I have not seen an instance where a few hundred dollars or like it's not even usually a few hundred dollars, usually less than that. The distance between what someone thinks their payment should be and what it actually should be.

Rob 00;19;55;15 - 00;20;16;24

And and most of the time there is a difference, right? Because if you're used to if you're especially if you're start a business and you're used to consumer financing rates, it can be an eye opener to get into a commercial loan and see, well, why are the payments this high? But I have never seen an instance where it made a difference in their business.

Jenn 00;20;17;00 - 00;20;46;01

So you make a great point. And I wanted to bring up a example of what had happened to me just about two weeks ago with one of our clients. And I may have spoken about this on a recent podcast as well, but I find it so interesting because there was a person who had gone in and gotten a different quote for paying cash versus financing because there's built in margin in there that these vendors are putting in.

Jenn 00;20;46;11 - 00;20;57;19

So you have to think that and it was about $30,000 on a $200,000 invoice. So they were up charging them $30,000 to use financing, not their financing. A finance company.

Rob 00;20;57;19 - 00;20;58;27

So that's like 15%.

Rob 00;20;58;27 - 00;21;20;25

Yep. Just on top of it. Just a here's a fee for you using a finance company. So I always find it so interesting when people are like, Oh, I'm going to a dealership and I'm getting 2% or 3% from Honda financing or BMW financing or Toyota financing. Yeah, absolutely. It's in house financing. The margin is built into the vehicle itself and a little bit into the financing itself.

Jenn 00;21;20;25 - 00;21;33;05

But if you were to say, hey, listen, I'm paying straight cash. Straight cash, what kind of deal can you cut me? You have way more wiggle room. So if you're still negotiating cash, like there's definitely a win with that.

Rob 00;21;33;10 - 00;22;01;23

So essentially what you're saying is that there's no such thing as free, which is the first rule of economics, right? Take economics. In college, they tell you it's actually the name of a chapter in a famous economics textbook, that there's no such thing as a free lunch. Right. Because if whether I'm Caterpillar or Kenworth and we're going to lead with, you know, most of the large equipment sellers lead with 0% rates or 2.9% rates.

Rob 00;22;02;01 - 00;22;19;26

But the truth is there's no such thing as free. They have to pay to borrow the money that they're going to lend so that you can buy their equipment and they have to underwrite the risk. And so in order to do that, of course, they have to inflate the price.

Jenn 00;22;20;01 - 00;22;39;21

Absolutely. So there's actually a company that I used to work for before that they would have specialty deals for vendors and dealers where they would essentially it would be 0% with that lender. But when reality, it's not 0%, the manufacturer or the or the vendor that was selling the equipment is one actually paying for it. Why would they do that?

Jenn 00;22;39;21 - 00;22;59;23

Why? Because their job is to sell equipment. So what makes the equipment easy to sell? 0% financing, It pushes up sales. So at the end of the day, it's not really 0% financing because someone's going to pay for it, Right? In that sense, it just happened to be the manufacturer and a lot of the times it's built into that and that's a lot more on the consumer side.

Jenn 00;22;59;23 - 00;23;11;21

I see that as well with, Oh, well, you're coming into our dealership, our brand or whatever. We're able to get you a good deal, right? Fair enough. But the nothing is free. It's not like you're saying it's not actually 0%. Good point.

Rob 00;23;11;26 - 00;23;45;02

So thanks again for tuning in. And we have a big ask because we've spent some time brainstorming episodes and we have a lot of episodes in store for you, but it would be even better to do episodes based on what you want to hear. So if you go to the podcasts page on our website, W WW dot Smarter Finance U.S.A., there's a form to fill out where you can submit a request for an episode, and we'll do the episode and even send you an email to let you know when it's live.

Jenn 00;23;45;04 - 00;24;03;00

Love it and feel free to comment on this podcast or any of these videos that we have. They're also uploaded on YouTube. Give us a comment below like it. Let us know again. You can pop there and give us ideas to talk about different things. And yeah, we really appreciate you tuning in this season. And once again, my name's Jennifer Casey.

Rob 00;24;03;06 - 00;24;03;21

And I'm Rob.

Jenn 00;24;03;21 - 00;24;15;13

Marshall, and we hope that if you're going to do something, that you do it smarter.

Rob 00;24;17;24 - 00;24;47;23

Thanks for watching or listening. If you're listening through a podcast app, we would love it. If you would be so kind as to leave a review. If you are watching this on YouTube, it would mean the world to us if you left a comment or gave us a big thumbs up. And lastly, if you're looking at us on the website, if you would let us know an episode that's of interest to you, that would be fantastic.