Captive Financing

What is captive financing?

Captive financing is a cost-effective risk management tool for larger corporations and retail chains that allows them to offer credit to their customers while limiting their risk and containing it within a subsidiary company. Corporations establish captive finance companies in order to provide a convenient in-house way to provide and administer financing for purchases from the primary corporate entity. Typically, captive financing is used to fund major purchases including cars, trucks, boats, appliances, or other high ticket items. Some major retailers also offer captive finance arrangements in the form of store cards that can only be used to purchase goods and services from their retail outlets.

Captive financing in practice

One of the most common examples of captive finance is found in the automotive industry, where subsidiary companies handle the credit arrangements for consumers who purchase cars and trucks from major automobile manufacturers like Ford or General Motors. Unlike companies that offer credit to their customers directly, corporations that deal in captive financing keep the financing portion of the business separate from the main concern. This allows them to safeguard the primary corporate entity from the financing portion of the business, separating it from the additional risk incurred by extending credit. In many cases, captive financing subsidiaries offer higher-risk loans at higher interest rates in order to attract customers to their businesses; this is especially true in the new car and truck industry, where the loans are collateralized with the vehicles purchased.

Captive financing in retail chains

Large retail chains can increase their potential sales and improve customer loyalty by offering captive finance arrangements for funding major purchases like appliances or high-end furniture or by extending a line of credit through a store credit card. Because the captive financing company is a wholly-owned subsidiary of the retailer, applications can be assessed and approved within minutes in most cases, rather than the days or weeks necessary for traditional analysis of creditworthiness. Customers who apply and are approved for these store credit arrangements may also be eligible for discounts on purchases or other incentives that can increase their loyalty to the retailer.

Benefits and drawbacks of captive financing

For consumers, captive finance companies can provide an avenue for financing major purchases and obtaining a line of credit even for those with limited or no financial history or negative information on their credit reports. Because captive financing companies have a vested interest in making as many viable loans as possible in order to promote the profits of the primary business, many consumers can obtain credit in this way when other credit options are essentially closed to them. However, this flexibility and willingness to risk comes with a high price tag in many cases. Higher interest rates, more restrictive terms and, of course, the requirement that the credit be used only at the issuer’s retail outlets can make captive financing a costly option for consumers. In many cases, lower interest rates and more favorable terms can be obtained from traditional lending sources.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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