Customer/Client/Patient Financing- Questions and Answers

For businesses evaluating customer, client, and patient financing options, selecting the right solution(s) can be complicated. Hopefully, the following will unravel some of the confusion.  

Q. What’s the difference between Direct-to-Merchant and Direct-to-Consumer financing?

With Direct-to-Merchant (DTM) financing, the funds for the transaction are paid directly to the business (merchant), less discount/financing fees. With Direct-to-Consumer (DTC) financing, the funds are paid directly to the consumer who in turn pays the business (merchant) to complete the transaction. 

There are differences from a pure transactional basis. Primarily, with DTM financing, typically the loan application is firmly decided at the point of sale and if approved, the funds are cleared immediately. With DTC financing, the application is pre-approved within seconds but the transaction cannot be completed until the funds are received by the merchant. Also, the pre-approval is typically subject to certain stipulations, usually verification of the applicant’s income as presented on the application. 

There are other differences in the structure of the financing. With DTC, the consumer’s APR will vary based on their FICO credit score. Individuals with very good credit scores will typically do better with DTC than DTM when it comes to APR. Also, the cost to the merchant is usually better with DTC. With DTM, the consumer’s APR is usually fixed but the cost to the merchant will vary based on the consumer’s risk assessment. From the standpoint of loan amount, DTC lenders tend to offer higher maximum loan amounts in most cases.  

Q. What determines a business qualifying or not qualifying for a Direct-to-Merchant lender?

DTM lenders will look at various criteria in determining whether or not they will take on a new merchant. The first factor is industry or vertical. Every DTM lender has a certain criteria as to products and/or services they are willing to finance. Other general criteria such as geographics could apply as well. The lender will also evaluate the strength of the business including place of business, annual revenue, time in business, marketing and sales process, on-line and off-line reputation. In some cases, they will also evaluate the business owner(s), including credit rating and reputation. 

Q. Why is the business and the industry they are in so critical to lenders when evaluating a merchant’s qualification for Direct-to-Merchant financing?

The strength of the product/service being provided as well as the integrity and strength of the business has a direct correlation as to whether or not the borrowers will pay back their loan with the lender. If a product or service is subject to buyer’s remorse or dissatisfaction, the likelihood of default increases substantially. Unlike with DTC financing, where the loan is funded to the borrower who in turn willfully pays the business, with DTM financing the connection between the funds and the business is direct. The borrowers tend to feel a disconnect from the money. If a business closes operations, it is likely that the borrowers will discontinue making payments. The vetting of a merchant by a DTM lender can take anywhere from a few days to weeks. 

Q. What businesses have a challenge using Direct-to-Consumer financing?

DTC can work for any business, but the process can be awkward for some business types. DTC is not ideal in a retail environment where the expectation is for the sales to be completed immediately. Retail businesses tend to rely on impulse buying decisions and a delay can result in a consumer changing their mind or provided the time to shop for alternatives. Another scenario could be health and veterinary care where time is of the essence. 

Q. What impacts the outcome of a Direct-to-Consumer loan application?

 The DTC loan application is primarily a FICO Score driven approval process. There are other factors as well, such as debt-to-income ratios (the lender’s way of determining the affordability of the loan payment) and financial trends. It’s important to understand two factors when it comes to FICO scores and credit reports. First, there are 16 FICO Score models. So, a credit score obtained from an online source may not match the score that the lender evaluates. Also, pre-approvals are based on soft credit pulls, which have no impact on the consumer’s credit rating. Soft credit pulls may not catch everything that a hard credit pull does . Once a consumer goes forward with a loan offer, the lender will require a hard credit report and in some cases additional information can impact the decision making process. They will also, in most cases, verify the income that is stated on the application and if the income is not substantiated, it is possible that the applicant will no longer qualify. 

Lenders, whether they are DTC or DTM, have certain appetites for risk. Some lenders will take few risks and the reward for the applicants they approve are very aggressive terms. Other lenders are willing to take on more risks, in degrees, and the terms of the loan will reflect those risks. They understand that a certain number of defaults will occur but their pricing is designed to make up for the losses. 

Q. What is a customer financing waterfall?

 Fintech businesses, such as Flexxbuy (and others), offer a one application, multiple lender option for businesses/merchants and consumers. There are a number of ways to present offers through a platform. One is to present all the offers at once and let the merchant and consumer decide which is best. In general, that’s the approach that Flexxbuy takes in its platform. The alternate approach is to set up the lenders  in order based on risk appetite and continue presenting the application until an offer is received. This is an approach taken by some DTM platforms.

There are pros and cons to each approach. Flexxbuy goes with the present all approach because it believes that algorithms shouldn’t decide which of possible offers are presented. Also, the selection of offers is not always clear cut. There is nuance to offers and what is better for one consumer may not be better for another consumer. For instance, if a consumer believes they only need the loan for a short time, they may prefer a 0% same-as-cash option, which typically allows the borrower to not pay interest if the loan is paid off within a certain time period. If they consider the loan long-term, interest may weigh less than the monthly payment.

Q. What options do the business and prospective customers have that are declined for lender financing?

Unfortunately, there is no magic bullet when it comes to financing. For some consumers, there is no lender willing to take the risk. For businesses that are able, in-house financing could be an answer rather than turning away a prospective customer. Businesses can either do it themselves or have a third party, such as Flexxbuy, handle it for them. In-house financing is essentially a payment plan that pays the business when (and if) the payment is received. For businesses with low product or service costs, collecting an initial deposit may cover whatever costs are associated with the sale, making it worth the risk.

The advantage of utilizing Flexxbuy for in-house installments is that it is essentially hassle free. Flexxbuy does all the heavy lifting when it comes to administrating the loan. Also, to the consumer, a Flexxbuy installment offer looks similar to any other third party loan which increases the likelihood of payback. In addition, costs to the businesses associated with the administration of the plan be be offset by interest charged to the consumer. And if a consumer defaults, it will be reported to the credit bureau. 

While not a perfect solution, many businesses believe that a sale of any kind is better than no sale what-so-ever.

Q. What costs to the business are associated with a customer financing transaction?

Typically, businesses will pay a discount or funding fee on customer financing products. On DTC financing, the fees are generally charged after a loan is funded and funds are received by the business. On DTM financing, the fees are generally deducted prior to the funds being sent to the business. The amount of the fees vary per program and in some cases, per lender. 

Q. How does customer financing impact a consumer’s credit?

In most cases, the initial loan application to explore options only requires a soft credit pull. Soft credit pulls do not result in an inquiry so there is no impact on the consumer’s credit report. Some of the DTM lenders only do hard credit pulls which will result in an inquiry. An inquiry will usually reduce a FICO score by 2-3 points. In all cases, once a loan offer is accepted, the lender will do a hard credit report.

From the standpoint of the loan itself, customer financing loans have the same impact on credit as any other debt. In general, installment loans have less of a negative impact than utilizing credit cards. As with all debt, on time payments are critical and defaults will have a large negative impact on credit score and lendability.

Q. What does recourse to the merchant mean?

Some lenders have a recourse or satisfaction guaranteed provision that typically apply to the early stages of the loan period, usually 30 to 90 days. These provisions will usually only impact businesses that are considered high risk (businesses that are prone to buyer’s remorse and high rates of dissatisfaction). Some lenders will have an open recourse policy subject to their discretion.

If recourse is enacted, the lender will refund the money to the borrower and take back the funds from the business. 

For certain businesses, a reasonable recourse provision can be beneficial. It reduces the number of complaints and bad reviews which can be highly detrimental to the business and business ownership. The savvy business will factor in a reasonable level of recourse into their revenue model. 

Q. What is a lease purchase?

A lease purchase is a way of taking possession of consumer goods through a lease program. The lease will typically be up to 12 months (sometimes longer) and have an ownership option at the end. The true cost of a lease can be quite expensive. A conversion of the payback into an interest rate would typically result in a rate of 100%+. Lease purchase solutions are usually much more flexible when it comes to credit worthiness than an installment loan or credit card.