Kicking the Tires: Risks and Opportunities in Lending to Used Car Dealers

Not long ago, the pandemic and supply chain shortages caused major disruptions in the new and used vehicle markets. When production lines shut down, demand for used cars—and their prices—skyrocketed.

Though the pandemic is largely in the rearview mirror, and inflation is moderating, Americans continue to look for ways to stretch their paychecks. That includes foregoing new cars for the used vehicle sector, where demand, while not at the peaks of a few years ago, remains strong.

Retail sales of used cars registered $13 billion in September 2024, according to the Federal Reserve Bank of St. Louis. That was down from a high of $17.2 billion in March 2023, but well above the pre-pandemic high point of $12.3 billion in March 2019.

In units, retail used vehicle sales were at 1.54 million in September 2024, down 2% from the previous month. And prices have eased somewhat but were still up significantly since the pandemic. The average used vehicle listing price was $25,172 in September, compared to about $19,500 in February 2020.  

This shift in sales and pricing reflects changes in supply. Inventory at franchised and independent dealers rose at the start of September, reaching 2.18 million units, according to Cox Automotive's analysis of vAuto’s Live Market View. Yet availability remains limited for lower-priced vehicles, with cars under $15,000 showing a 31-day supply—the lowest since March 2021.

Whether lending to used car dealers is a business line you are already engaging in or an opportunity you are considering, this article’s information on the industry trends and market forces shaping the used car dealer environment will help guide your decisions.

An Overview of the Used Car Dealer Industry

The nation’s 23,700 used car dealerships employ about 163,000 workers and generate $169.5 billion in annual revenue. The average dealership operates from a single location, employs six to seven workers, and brings in $7.2 million annually.

Most used car dealerships sell pre-owned vehicles sourced from the general public and other suppliers. Automobiles and light-duty trucks represent over 90% of sales, according to U.S. Census Bureau data.

Unlike new car dealerships, used car dealers generate minimal revenue from maintenance and repair services, often outsourcing these to third-party providers. This reliance on outsourcing contributes to the smaller facility size of most independent dealerships, with typical spaces under 2,500 square feet, according to the National Independent Automobile Dealers Association.

The industry is concentrated at the top but fragmented overall: The top four companies generate about 20% of industry revenue. Major players include CarMax, DriveTime, and America’s Car-Mart, with AutoNation and Penske Automotive Group also operating in the used car market.

Examining the Operations of Used Car Dealerships

Used car dealers provide a wide variety of makes and models suited to the preferences and needs of their local markets. Some focus on specific brands or vehicle types, such as German brands (Audi, BMW, and Mercedes) or luxury models. Other types of dealerships include consignment lots that sell vehicles on behalf of private sellers who prefer to avoid managing the sale themselves. Consignment dealers typically emphasize lower-priced vehicles that new car dealerships may not offer due to the vehicle’s age.

Dealers in the used car sector acquire their inventory from numerous sources, including auctions, new car dealerships, wholesalers, finance and leasing companies, rental agencies, and fleet operators. They also accept trade-ins based on appraised values. While some dealers repair and recondition used cars, others sell them “as-is," without warranties. Inventory can range from fewer than 10 vehicles to several hundred.

Financing is critical in used car sales. Some dealers partner with finance companies, banks, or credit unions to help customers secure loans, while others offer in-house financing. “Buy here, pay here” (BHPH) dealerships directly finance purchases based on the customer’s credit. These dealerships often cater to buyers with poor credit who cannot obtain traditional auto loans. Approximately 45% of BHPH dealers install tracking devices in vehicles to monitor location or disable the vehicle if loans default.

Used car dealers typically employ sales staff who work on commission; some also earn an hourly wage. BHPH dealers often have collectors who manage accounts, process payments, and handle delinquencies. Marketing strategies encompass both traditional media (TV, print, radio) and digital platforms (websites, social media, apps). Referrals are a key source of new business, while repeat customers contribute to growth.

Competition for traditional used car dealerships is intensifying, with online car marketplaces like Carvana and Vroom emerging as digital alternatives. These platforms offer a fully online buying and selling experience, sourcing vehicles nationwide and delivering them directly to customers’ homes, while managing title transfers and paperwork online. Carvana even provides a seven-day return policy. Although many traditional dealerships offer online browsing, they still primarily depend on in-person transactions.

Risks and Challenges for Used Car Dealers

The road can be bumpy for used car dealerships as they face several significant industry challenges.

Vulnerability to Economic Conditions

Economic fluctuations influence consumer spending and the accessibility of vehicle financing. Both new and used car sales decline during economic downturns as consumer income and financing options become constrained. Buyers with poor credit are particularly impacted when credit conditions tighten, and interest rates increase. For instance, during the 2008-2009 recession, used car sales dropped after a period of growth. However, this economic weakness can be partially offset by “payment walk,” where sticker-shocked consumers shift from buying new cars to purchasing used vehicles with more manageable payments.

Competition From New Car Dealers, Online Platforms, and Private Sellers

Used car dealers face competition from multiple sources, including new car dealerships and online marketplaces. Many new car dealerships also sell used vehicles, which are generally newer and more expensive than those found at used car lots. Additionally, new car dealers frequently provide pre-owned vehicles with warranties backed by the manufacturer, offering similar benefits to new car warranties. Meanwhile, online platforms like Craigslist and Facebook Marketplace connect buyers and sellers directly, eliminating traditional intermediaries. Of the roughly 36 million used cars that were sold in the U.S. in 2023, about 17 million were not sold through a retail channel, according to Cox Automotive.

Uncertain Sources of Supply

The supply of used vehicles fluctuates due to factors such as the total number of vehicles on the road and the volume of new car sales. New car purchases often result in trade-ins, which feed the used vehicle market through retail channels, wholesale deals, and automotive auctions. When Americans delay buying new cars due to economic conditions, changes in driving habits, or improvements in vehicle quality, the used vehicle market contracts. This leads to an older and therefore less valuable inventory. The average age of cars and trucks in the U.S. rose from 8.9 years in 2000 to 12.5 years in 2023.

High Cost of Inventory

The used car dealer industry is highly capital-intensive, with most companies needing external funding to build inventory, which represents 55-59% of their total assets. Since used car customers are often considered higher risk, firms—particularly small and BHPH dealers—may struggle to secure financing at favorable rates. BHPH dealers face additional risks as they provide direct financing to customers and typically stock older inventory. Vehicles that sit on lots for extended periods tie up cash and incur interest costs for dealers.

Ride- and Car-Sharing

Ride- and car-sharing programs are prompting many Americans, especially younger ones, to rethink the necessity of car ownership. Young adults accustomed to ride-sharing services like Uber and Lyft are more inclined to avoid the costs of owning a vehicle, even an affordable one. While such services could reduce car ownership, recent studies suggest that vehicle ownership has actually slightly increased in metropolitan areas since these platforms began operating.

Other Underwriting Considerations for Used Car Dealers

Lending risk for used car dealerships is influenced by multiple shifting factors, including inflation, vehicle values, and underwriting losses. Other major factors include:

• “Leftover” Inventory: Small, independent used car dealers are often left with the oldest and riskiest vehicles—commonly referred to as “leftovers”—because new car dealers retain the best trade-ins, and the next-best options generally go to brand-name dealer-only auctions.
• Access to Capital: Small dealers often struggle to achieve the scale preferred by lenders and have limited options for securing capital. Larger dealerships, by contrast, benefit from easier access to funding due to their size and lenders’ preference for established operators. As a result, small dealerships may rely on self-funding or face higher borrowing costs.
• Reputational Risk: The car sales industry battles a persistent negative reputation, with used car dealers facing heightened scrutiny. Unscrupulous dealers may fail to disclose critical details, such as whether a vehicle was previously a rental, involved in an accident, or has hidden damage. Additional deceptive practices include odometer tampering and “title washing”—relocating salvaged vehicles to states that do not identify prior issues on titles.

Lenders should consider these critical questions when evaluating the risk of lending to a used car dealership:

• Used car dealers often operate with high leverage. How is the dealership’s floor plan financed?
• Field exams are strongly recommended. Has the dealership completed a recent field exam, and is it available for review?
• What is the dealership’s employee attrition rate?
• Does the dealership finance in-house or through a third-party provider? If in-house, how does it assess creditworthiness, and what percentage of its lending portfolio is subprime?
• What are the dealership’s primary advertising strategies?

Trends in the Used Car Dealer Industry

Overall Growth Remains Volatile

Sales for used car dealers have fluctuated significantly in recent years. In the U.S., total sales for used car dealers increased by 4.3% in 2019, then dropped by 2.7% in 2020. While the COVID-19 pandemic temporarily slowed sales, demand quickly rebounded, resulting in year-over-year gains for much of late 2020. When supply chain disruptions in 2021 limited new vehicle production, used sales rebounded sharply with a 41.6% increase. Then they slipped 0.7% in 2022 before rising 2% in 2023.

Declining Used Vehicle Prices

After 2021’s peak, higher interest rates have slowed used vehicle purchases, while an increasing supply has also driven prices down. After surging by 42% in 2020 and 28% in 2021, the average price of a used vehicle fell 3.7% to $27,143 in 2022, according to Kelley Blue Book. By early September 2024, the average listing price had declined further to $25,172, down from $25,425 in August.

Inventory levels have significantly influenced pricing. At the end of 2022, dealers had just a 36-day supply of used vehicles priced under $10,000, compared to 51 days for those priced between $10,000 and $20,000, 57 days for $20,000-$25,000, and over 60 days for vehicles priced above $25,000. Historically, inventory levels have ranged from 66 to 71 days, and by the end of 2023, average inventory levels had returned to a 71-day supply.

Changes in Loan Rates, Terms, and Down Payments

Interest rates for used vehicle financing have risen sharply in recent years. After peaking at 9.5% in 2019, the annual percentage rate (APR) dropped to 7.7% in 2020 before climbing steadily, reaching 8.2% in Q2 2022 and 11.3% in Q3 2024.

Loan terms have also fluctuated, increasing from an average of 68.1 months in 2020 to 70.1 months by Q3 2023, before declining slightly to 69.5 months in Q3 2024. Meanwhile, average down payments have risen from $3,283 in 2020 to $4,165 in 2024.

Accelerated Shift to Digital Transactions

The pandemic significantly accelerated the adoption of digital tools in the used vehicle dealer industry. With dealership and auction closures disrupting traditional operations, firms rapidly turned to online platforms for buying and selling. Digital transactions offer enhanced transparency, simplify the trade-in process, and help minimize the high-pressure sales tactics that have long frustrated customers.

Companies like ACV Auctions have further streamlined online transactions. Its technology tools include car title scanning and electronic document recognition, which reduce paperwork and expedite the buying process. Additionally, ACV has introduced a “virtual lift” that allows dealers to digitally inspect vehicle undercarriages, along with audio motor profiling technology to detect potential engine issues. Such innovations not only improve efficiency but also build trust among buyers and sellers.

 ABOUT AMY SHORT

Amy Short is the director of research at Vertical IQ, a company that provides Industry Intelligence for understanding a borrower’s risks and opportunities. Vertical IQ equips users with the confidence and credibility to make memorable first impressions and sustain enduring relationships. They also contribute industry reports to eMentor, RMA’s research tool for credit and lending professionals.

To learn more about Vertical IQ, you can visit verticaliq.com or email them at info@verticaliq.com.