Outsiders Challenge the Status Quo in Auto Lending

Most Americans finance an automobile purchase today the same way they have for decades. They traipse over to the local car dealer, sit down with a salesman and, if they're savvy, haggle over loan terms.

Now TrueCar, a startup that has already moved much of the car-shopping process online, is looking to remake the borrowing experience, too. The Santa Monica, Calif.-based firm announced last month that it had raised $30 million, which it will use largely to build infrastructure that will enable consumers to arrange vehicle financing over the Web.

"What we're talking about doing is allowing the consumer to apply for the car loan or the lease while they're sitting at home," says Scott Painter, TrueCar's chief executive officer. "It's designed to basically take a lot of that work that normally would be done at the dealership and do it in advance."

TrueCar is one of several recent entrants in the car industry that aim to modernize the auto finance business. These companies approach auto lending from sharply different perspectives — they include a car manufacturer, a data provider to lenders, and even an upscale taxi service. But each, in its own way, is dragging the slow-to-adapt industry into the future.

TrueCar, which markets itself to consumers with the slogan "Never Overpay," says that its users currently account for about 2.3% of all new car sales nationwide. The site partners with thousands of car dealers in all 50 states, which agree to provide a guaranteed discount from the manufacturers' suggested retail price.

From the consumer's perspective, the current version of TrueCar.com has significant limitations. It provides users an estimated monthly loan payment, but then informs the shopper that they'll need to visit the dealer in order to arrange actual financing.

"I think that the experience, in that dimension, falls a little flat, and we're very aware of that," Painter says.

TrueCar plans to use much of the $30 million influx from Vulcan Capital, which invests the wealth of Microsoft co-founder Paul Allen, to build out its ability to process auto loan and lease applications.

The loans themselves will not be much different than those being made today, though they should be less expensive to process. They'll be indirect loans — provided by a bank or another finance company, and brokered by the auto dealer, which will retain the ability to add a markup. TrueCar will simply provide the technology to enable the transaction to happen with greater efficiency online.

But from the consumer's standpoint, the borrowing experience will be markedly different — shopping online eliminates the haggling and the face-to-face sales climate of an auto dealer. The consumer's experience will be more akin to arranging a direct auto loan through a bank than going to an auto dealership, Painter says.

"The customer gets all the benefits of a direct experience. The dealer gets all the benefits of an indirect loan," he adds. "So it's literally a sort of hybrid of those two separate channels in a way that works best for everybody."

Other companies are also finding ways to transform the decades-old methods of financing vehicle purchases.

Tesla Motors (TSLA), the electric car company founded by Elon Musk, has eliminated the role of auto dealers altogether. The company operates its own stores, with financing provided by Wells Fargo (WFC) and U.S. Bancorp (USB).

Under the Tesla model, the middleman is gone, and so too is haggling.

"Our stores are designed to be informative and interactive in a delightful way," Musk wrote in a 2012 blog post, "and are simply unlike the traditional dealership with several hundred cars in inventory that a commissioned salesperson is tasked with selling."

Another paradigm-shifting announcement came late last year from Uber, the fast-growing, app-based taxi service. The San Francisco-based company has had trouble keeping up with demand for rides, so it's decided to try to attract more drivers by defraying the cost of financing a vehicle. Uber says such loans will carry less risk than traditional auto loans, because they will come with an income stream.

"The average, fully utilized car on the Uber platform grosses $100,000/year," Uber spokeswoman Nairi Hourdajian said in an email. "That robust, reliable cash flow lowers the risk for financing drivers and facilitates better access to better terms than drivers would otherwise be able to access."

Few details have been made public, but Uber says the loans, which will be available initially as a pilot program in six U.S. cities, will significantly reduce drivers' monthly car payments. If the borrowers quit driving for Uber, their interest rates will rise.

And if the driver defaults, "Uber still owns the cars and doesn't suffer any loss because they can pass the car to someone else," Tomasz Tunguz, a partner at the venture capital firm Redpoint Ventures, said in an email.

Uber's growth portends major changes in the auto finance sector, but most of the innovations are happening in more incremental ways. Black Book, which provides pricing information to auto dealers and lenders, introduced a new Web portal last month that's designed to make it far easier for lenders to determine the likely resale value of vehicles.

The Black Book portal, called the Collateral Insight Engine, allows lenders to easily compare the likely resale value of comparable car models. For example, if a Toyota Avalon is likely to retain more of its value than other full-size sedans are, that's useful information to a lender, which might decide to offer longer loan terms to Avalon buyers.

"It helps them not only reduce the risk in their portfolio," says Jeff Bunch, vice president at Black Book Lender Solutions, "but also find out what little pockets of risk they might have to be a little bit more aggressive."

Some of the recent innovation in the auto finance sphere has resulted in a backlash — a lesson learned by Tesla, which has incurred the wrath of auto dealers. TrueCar, meanwhile, decided to dial back its advertising message after its dealer partners complained that its policies were driving down sales prices.

Today, TrueCar CEO Painter downplays the idea that his company is disrupting the auto sector. He says that the company remains committed to partnering with auto dealers, rather than competing against them, and argues that TrueCar's new online loan and lease platforms should make it easier for dealers to close the deal with shoppers.

"I don't think we've ever set out to be disruptive," Painter says. "We're innovators. We're trying to really focus on solving not just the consumer problem, but also the dealer problem."

But Arjan Sch#umlautu#tte, founder and managing partner at the venture capital firm Core Innovation Capital, says that what TrueCar is doing is part of the transformation of the automobile purchase. He sees its model as reflecting a trend toward greater price transparency for consumers. "The truth is that they are bringing margin compression to the dealers," Sch#umlautu#tte says. "More transparency equals less profits."