Today begins our new series of blog posts examining the various steps of successfully offering payment plans, and how to maximize the effectiveness of your in-house financing program. To begin, we’ll look at various factors that effect your total return on the payment plans you offer. How you can make the biggest return on your loan by controlling a key factor: proactively controlling default rates.
How should one calculate possible returns from an in-house financing program? First off, an in-house system means helps you accept patients that have been turned down by 3rd party financing companies. Part of your total return is calculating the fees that would have been paid if the patient had been approved. These discounts are typically in the 5-10% range for prime or near-prime credit, and higher for lower credit. So, we can count that amount as part of your return. We can also add the interest that will be paid on the payment plan. From that, subtract the hard default rate — essentially the percentage rate at which customers default completely — as a percentage of the total dollar amount. Finally, subtract the interest you would have earned on the discounted amount you would have received if you had been able to get the customer approved by a 3rd party lender.
A simple example would be a $3,000 dollar procedure, with $600 up front, resulting in a $2,400 loan. Assume a 12 month at 10% payment plan and the 3rd party discount rate is 8%. With a 4% return on your money from the 3rd party financing company, you would have $2,546. Doing a payment plan, assuming a 2.5% hard default rate, you would have almost $250 in additional net profit – 10% straight to the bottom line
Exploring the math theorized above is beyond the scope of this blog post, but it should be clear that there’s potential for strong returns, especially if the hard default rate can be kept in check. There are a number of tools practices can use to control the hard default rate, but let’s first clarify the difference between hard and soft defaults.
A soft default occurs when someone simply misses a single payment. Often soft defaults are nothing more than a small hiccup on the part of the debtor, and before you know it, they’re back on track. But if you cannot get the debtor back on track, then you are faced with a hard default on the remaining amount of the payment plan.
Unfortunately, missed payments are an inescapable element of the payment plan process. Therefore a crucial component in maximizing returns must be controlling the rate at which soft defaults become hard defaults.
Our next three to four blog posts will explore how a practice can construct their in-house financing program to minimize soft defaults and do everything in their power to get them back on track. Our theme across the board will be a proactive (as opposed to reactive) approach to origination, assessment, and collection. In the case of defaulted payments, many practices take a reactive approaching; waiting 30,60 or 90 days to make phone calls or thinking that a simple call will get them back on track. But as these defaults add up from month to month, they can easily fall by the wayside, greatly expanding the default rate. However, a proactive approach — i.e., automated software with payment reminders and immediate follow-up — can prevent and handle soft defaults in a uniform manner, and greatly increase the return on the investment.
Next week, we’ll look at managing the risk with in-house financing by creating a consistent workflow in terms of evaluating and approving payment plans.