When I was Internet Manager for a major car dealer, the customers who got the best deals almost always focused on the selling price of the car, and not on monthly payments. Why? Let’s take the example of Bob, who is trading in a large SUV on a fuel efficient, basic sedan.
Bob tells his salesperson, Dan, that he has to get the monthly payment down to $300 a month so he’ll be able to meet his other monthly obligations. But he is disappointed when he discovers that the dealership can only it down to $360 per month. Bob gets upset. He tells Dan that he won’t make the deal at this price, that the payment had to be reduced to $300 or less, or he’ll take his business elsewhere.
After hearing Bob’s ultimatum, Dan asks: “If I can get your payment down to $300 per month do we have a deal and you drive this car home today?”
According to Plan
You may think that Bob is in control of this situation. In fact, he would be shocked if he realized that the salesperson has him right where he wants him. First, Bob really wants this new car. Second, he is focused on monthly payments instead of the selling price and terms of the loan. Why is this bad for Bob? Let’s watch what happens next.
Incredibly, the dealership comes back with a monthly payment of $300 per month. This is exactly what Bob wanted. A reasonable person sees a drop of $60 per month in the payment structure (from $360 to $300) and does a little math to see how much is saved. The length of the car loan is 60 months (five years) so Bob’s saving should be:
- $60/month x 60 months = $3,600
However, Bob is only concerned with his monthly payment. He didn’t notice that the dealership reduced his payment to $300 per month by extending the term of the loan from 60 to 72 months instead of lowering the selling price of the car. So instead of Bob paying:
- $300/month x 60 months = $18,000 total cost of the vehicle
Bob is instead paying:
- $300/month x 72 months = $21,600 total cost of the vehicle
The difference between the two is:
- $21,600 less $18,000 = $3,600
The dealership was able to lower Bob’s payments but didn’t discount the price of the car one penny. If that wasn’t bad enough, they asked Bob to increase his down payment an additional $1,000, which Bob agreed to do. This allowed the dealership to add a few percentage points to the loan, increasing their profit by an additional thousand dollars. Because the down payment offset the increased cost due to the rising interest rate, the payment remained at $300, but cost Bob another $1,000.
Good News Bad News
The good news for Bob is that he was able to buy a car for $300 per month. The bad news is the dealership made an extra $4,000 to $5,000 profit on a deal that Bob will be paying for over the next 72 months (six years). If Bob had negotiated the selling price of the car and the terms of the loan instead of monthly payments, he would have saved a lot of money and still been able to get his monthly payment where it needed to be.
The moral of the story is 1) negotiate one price: the selling price of the vehicle and not the monthly payment and 2) be pre-approved for your car loan when you walk into a dealership to make sure your borrowing costs are as low as possible.