Car Shopping Tip: Steering Around "Profit Points"

April 11, 2011

Car dealers are between a rock and a hard place. 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 deals on the selling price of new cars.

As a result, it’s more difficult for dealers to sell cars for the full Manufacturer Suggested Retail Price (MSRP) because many buyers arrive at their showroom knowing the actual invoice price—if not the dealer’s actual cost—for the vehicle they want to buy. This puts them in a strong negotiating position. And to get business, a competing dealer is often willing to undercut almost any price another dealer quotes—even if, at times, it means losing money on the selling price.

Yet, just because times are tough 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 a car dealer sells a car, they have many opportunities to make a profit.  Each one of these 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 price the dealer actually pays from the selling price for a given vehicle, and you’re left with the gross profit on the deal. By the way, more and more consumers are catching on that the invoice price is not the dealer’s actual cost.

Trade value represents another profit point. Here’s an example: a dealer allows $10,000 for a trade. They turn around and spend $1,000 on shop costs that include new tires and brakes. They are able to resell it for $14,000. The profit of $3,000 goes a long way to keeping the doors open another day.

Financing options are another profit point that can add gross profit to any car deal. For this reason, buyers should get pre-approval on car loans before walking into a car dealer’s showroom. Pre-approval with a bank, credit union, or online lender helps guarantee the lowest possible interest rate, even when that loan is through a dealer.

Most car buyers simply walk into a dealership, choose a car, and let the dealer provide the financing. Easy as pie. However, this allows the dealer to bump the interest rate above what 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.

How much can this cost the consumer? Let’s take the example of a new car that sells for $20,000. By the time you add tax and fees and subtract your down payment, you need to borrow $15,000. Your credit rating is good so you qualify for a rate of 4.99 percent. However, the dealership adds two points to this. No big deal, right? Let’s find out.

The monthly payment on a $15,000 loan over 60 months at the dealer’s inflated interest rate of 6.99 percent is $297. However, if you had been pre-approved with your own lender your monthly payment with an interest rate of 4.99 percent drops to $283. That’s a difference of $14 a month. Multiply this by the 60 month term of the loan, and you discover that you’ll be paying an extra $840. This is the amount you would have saved if you had been pre-approved and known the interest rate you actually qualified for. If the dealer didn’t match or beat the lower rate, you simply complete the loan where the cost is less to you.

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