How Do Car Dealers Make Money on Financing?

Car Dealers

Car dealers are primarily in business to buy and sell new and used cars, but not every car dealership makes money on financing. Furthermore, it’s not just the way a dealer charges for financing that can determine if he or she makes money on it. How a car is bought under financing is also important. In case you are wondering how do car dealers make money on financing? Here are the methods they utilize;

1) Service Contract

These are contracts that can be purchased by the buyer. The dealer will sell the buyer the service contract, while the buyer pays for it himself. The dealers who sell these contracts make money on financing because they offer better rates and earn more from these contracts. They also earn more from the rest of the services that come with this contract.

A service contract is a good way for car dealers to make money on financing because the buyer thinks he is getting better rates through these contracts and has additional fees and services.

2) Holding Points of Rate

When a car is bought with the financing option, a point of rate can be purchased from the finance company. The dealer offers to pay this point of rate to the finance company on behalf of the buyer, who saves money. The reason why dealers sell these points is that they make money on that amount of money through fees and interest on a lower interest rate.

This is an excellent way for car dealers to make money on financing because the buyers who purchase it think they are saving money. This can come in very handy in situations where a buyer doesn’t have perfect credit and wants a good interest rate.

3) Down Payment

A down payment is the amount of money a buyer pays on a car as a deposit. It is usually made with cash and is not financed. The good thing about down payments is that it enables the dealer to make money on financing because when the buyer pays for interest or finance charges, it always rises. The dealers who sell cars with smaller down payments take advantage of this because they earn more interest from larger down payments.

4. Mark-Up

A mark-up is the dealer’s profit from selling a car. The mark-up is calculated using something called a gross profit percentage which is included in the written offer to purchase from the dealer.

This way of making money on financing is mainly undertaken by new car dealers. Used car dealers who sell their cars for a premium price make their money on financing through mark-up and by selling additional services to their buyers. They are therefore sellers of finance, as opposed to loan originators. New car dealers do not sell additional services and take advantage of the mark-up on their cars.

5) Trade-Ins

A dealer may also be able to make money on financing by charging higher interest rates on trade-ins. Any car that has been previously sold and is being returned by a customer will incur depreciation. Depreciation is the decrease in value of a car that occurs as it gets older, and which is incurred because of normal wear and tear on a car.

Therefore, any car that has been sold and resold multiple times will have a lower value when it is returned to the original owner. The less a vehicle’s value decreases over time, the more it will cost a dealer to finance such a vehicle. Therefore, dealers who are financing fuel-saving cars or luxury cars can charge higher interest rates on trade-ins than those who are financing more common vehicles due to the greater depreciation of such vehicles.

6) Car Servicing and Parts

Because all cars require maintenance, repairs, and parts in order to function and to be kept in a like-new condition, servicing, repairs and parts are related to the cost of car financing. Vehicles that require more maintenance, repairs, and parts will have lower interest rates due to the greater costs of financing them.

7) Dealer Holdback

The dealer holdback is a practice by which some manufacturers, who are selling their cars at a price lower than their costs, allow dealers to withhold money from the sale price of the car and keep it as “holdback”, or set aside, for the dealer’s profit. For example, if a manufacturer sells a car at cost and wants to make a 30% profit on selling a particular model of that car, then the manufacturer may agree to pay the dealer holding back 10% of the selling price.

The holding back is a form of selling at a cost in which the dealer is not selling at cost, but is making a profit on financing. It serves the same purpose as “tacking on” or adding interest, but it is legal and has been used in the US and Canada for many years.

8) Car Finance Products

Car finance products are also related to the cost of financing. In general, customers do not like to have too much debt, especially for expensive cars. Therefore, the car finance product that a customer chooses affects the total cost of financing. A dealer may also make money on financing by offering customers different car finance products and charging different interest rates on each one.

9) Customer Service Fee

A customer service fee can also be related to the cost of financing. Customers do not like to finance more than they need at a time, so the dealer may charge a customer service fee in order to make money on financing. The amount of this fee will be based on the cost of financing and will be designed to recover the dealership’s costs and allow it to make money on financing.

10) Gap Insurance

Gap insurance can be provided by the car dealer or a third party, and designed to cover the difference between what a customer owes on his car and what is paid for it if the car is totaled, stolen, or written-off. Dealers can reap a profit from selling or financing gap insurance by charging a higher interest rate for it.

Furthermore, many dealers will not provide gap coverage at all, despite the fact that some customers prefer to have such coverage. The reason for this is due to the fact that this coverage is only available at a much higher cost from many other companies than the dealership provides, or because it may not be available at all.

11) The Dealership’s Overhead

There are many types of car dealerships. Each type has higher or lower overhead costs. The more overhead a dealership has, the less money it makes on financing and the more money it has to make on selling cars in order to turn a profit. This is because every car dealership needs to make some profit on every sale just to cover its overhead costs and stay in business as a going concern.

However, a dealership with very little overhead or no overhead at all may be able to make more money than it loses by selling cars below cost because such a dealership has no direct labor (sales staff) and operational costs. This is especially true when the owner of the dealership does not collect a salary for his or her management labor.

Therefore, it is important for non-finance car dealers to gauge their customers and determine the interest rate that will produce the most profit without shocking them with high-interest rates and balloon payments.

12) The Interest Rate of the Vehicle

The interest rate of a vehicle is also one of the three components that determine the finance charge rates and fees dealership charges for financing. In general, customers want to pay low-interest rates when financing their vehicles. However, customers are willing to pay higher interest rates on high-cost cars, because they believe that such cars will be worth more in the future when they decide to sell them. Therefore, dealers who are selling high-cost cars can charge high-interest rates while still making money on financing.

Furthermore, customers may want to pay lower interest rates when financing fuel-saving cars, because these cars are less expensive to operate than other types of vehicles. Therefore, customers who are buying such cars may be willing to pay low-interest rates on them in order to reduce their fuel costs. In such cases, dealers can make a profit on financing by charging low-interest rates.

13) Warranty Programs

Warranty programs are yet another way that dealers can make money on financing by charging higher interest rates. If a car costs over $20,000, then the warranty can be included in the total cost of financing. The warranty becomes part of the cost of financing, so it cannot be used as a loss-leader to lower interest rates on financing. If this is done, then the dealer will be able to finance more expensive cars with lower interest rates.

Conclusion

Car dealers make money on financing by selling the different ways of buying a car, as described above. How a deal is put together between the buyer and the dealer determines if he or she makes money on financing.