It’s crunch time for car dealers. Their ranks have been decimated by the downturn in the economy. If that weren’t bad enough, savvy car shoppers are using the Internet to negotiate great buys on the selling price of new cars. It’s no longer the norm for dealers to sell cars for the full Manufacturer Suggested Retail Price (MSRP). Instead, many buyers arrive at the dealership knowing the actual invoice price that dealers pay for the car they want to buy. This puts them in a strong negotiating position to make an even better deal.
Yet, just because there has been an economic slowdown does not mean that car dealers don’t have to pay their bills. However, if they are making less profit on the selling price of new cars, how are they meeting payroll and keeping the lights on?
Multiple Profit Points
When dealers sell a car, they have many opportunities to make a profit. Each one of these opportunities is called a profit point. The selling price of the car, truck, or SUV is the first profit point that most customers encounter. It’s also the easiest to understand. Subtract the invoice cost from the dealer’s selling price and you’re left with the gross profit on the deal.
Financing options are the second profit point that most buyers are forced to deal with.
If you’ve been following this website you know that I recommend that readers get pre-approved on car loans before walking into a car dealer’s showroom. Pre-approval at a bank, credit union, or online lender keeps dealers honest when they quote an interest rate for your car loan.
Most car buyers simply walk into a dealership, choose a car, and let the dealer provide the financing. This allows the dealer to bump the interest rate they charge above the rate the buyer actually qualifies for, called the “buy rate.” The difference between the buy rate and the interest rate the dealer charges is profit to the dealership.
A $20,000 New Car
Let’s take the example of a new car that sells for $20,000. Let’s also assume the car is bought on my home turf: the San Francisco Bay Area. Buyers around the country will be shocked that I’ll pay 9.75 percent local and state taxes on the car. This adds an extra $1950. By the time we add the DMV registration fee of $300, my total cost is $22,250.
Let’s say my credit score isn’t top tier, so I qualify for a buy rate of 4.99 percent. However, because I hadn’t sought out pre-approval at another financial institution, I didn’t know the dealership was adding onto the buy rate when they quoted me 6.99 percent. The extra 2 points will increase my monthly payment from $419.78 to $440.47. Over the 60 month term of the loan this will add an additional $1,241.40 to the cost of the loan. This is added profit for the dealer that I could have kept in my pocket.
It All Works Out in the End
So the dealer can discount the selling price well below MSRP, yet not lose a dollar profit IF they bump the buy rate on my car loan a few points. It's one way that dealers make up lost profit when consumers use the Internet to make better deals on the selling price.
Tomorrow, more financing tricks that dealers play.