Tuesday, July 10

Dealer Financing, Good or Bad?

The convenience of letting the car dealer handle your financing can be very expensive. In our world of immediate gratification, this price might be something you're willing to pay. But, you should consider the alternatives and the cost.

The ability for the average consumer to get invoice pricing information and wholesale used car values has put a huge dent in the dealers ability to make a profit on the car. Now dealers use other channels to create profit. One of the the biggest profit centers in the dealership is the Finance and Insurance Department (F & I Dept.).

Making a big profit on the financing is easy for the dealer if you're an uninformed buyer. But, because you're reading this, you can count yourself as one of the lucky few. Now you're going to be in the know, and you will be an informed buyer. Knowledge is power!

So, how does the dealer make a profit in the Finance and Insurance Department? They start off by making a deal with an indirect lender. This lender could be your local bank, or one of any number of national lenders. It's likely that the car dealer has a couple of lenders that they have this deal with, and the deal is mutually rewarding. The lender doesn't have to market directly to you nor do they need to employ a loan officer to talk with you about your financing, thereby cutting way down on their costs. Instead, the Finance and Insurance Manger who is an employee of the dealership (and who incidentally is paid on commission!) is working for the lender, filling the marketing role by promoting the bank to you, and fulfilling the loan officer role by helping to complete a loan application and forwarding it to an underwriter. Sweet deal for the lender.

So far, we've talked about how this deal rewards the lender. How does it reward the dealer? Makes them tons of money, that's how! You see, part of the deal with the bank is that the dealer gets a special interest rate known as the 'buy rate', which they are allowed to increase or 'mark up' by 300 basis points or more. This means that if the dealer 'buy rate' is 5%, they can (and will!) charge you (the 'street rate') 8% or more for the loan! When they do this, they get to keep the difference in finance profit. This can be a lot of money when you're talking about a big loan. Let's look at some numbers:

$28,000 Loan amount @ 3% interest rate (the difference between the 'buy rate' and 'street rate') over 60 mos = $2187.00 dealer finance profit. Not bad for an hours work in the F & I Department, eh?

Let's look at the difference between a 5% (the buy rate) and an 8% (street rate) payment for a $28,000 loan over 60 months. The 5% rate has a monthly payment that is $39 less than the 8% rate. Look at it this way; you can make $39 per month for the next five years simply by spending an hour today shopping for a good car loan rate before taking the dealer financing!

Shop around for a car loan BEFORE you go to the dealer! Get a low rate loan commitment from your bank or credit union before you go car shopping. Then, after you've found your car, let the F & I Department make a firm rate offer to you. If it's more than what your bank or credit union has offered, you have a couple of choices. Negotiate a better rate. Will they give you a lower rate if you have shopped? Almost guaranteed! Even if they can't mark up the rate even a whisker, they will still get the 'retention' pay. This is a flat fee paid to the dealer, normally around $150, just for taking the application and handling the paperwork. Of course, you can forgo the negotiation and just get your loan from the bank or your credit union.

Be sure to vist The Mint Blog to read more awesome articles like this one in the upcoming 108th Carnival of Personal Finance!