Categories: Auto Loans & Financing
Do Car Dealers Make Money on Financing Your Auto Loan?
Car dealerships usually offer financing when you buy a vehicle, simplifying and centralizing the car-buying process for the customers.
Car dealerships usually offer financing when you buy a vehicle, simplifying and centralizing the car-buying process for the customers. When financing through a dealership, buyers only need to choose the car they want, have a down payment, and let the dealer do the legal work for it to happen.
With that said, do dealers make money on financing your auto loan? The short answer is yes. Auto dealerships make a lot of money off financing; in fact, it’s a huge area of profit.
Dealers mainly act as middlemen to connect their clients with banks and credit unions. In the process, they earn either a flat fee for every loan referral, a percentage of the loan amount, or a share of the interest. While some auto loans earn a dealer relatively little, most generate thousands of dollars in profit.
How car dealers make money from financing
The most common way car dealerships make money from financing your auto loan is through the markup on interest rates. As they work with the bank or credit union to secure auto loans for customers, dealers have the ability to increase the interest rate offered to the buyer. This markup, commonly known as the dealer reserve, allows a dealership to earn a percentage of the interest paid by the borrower over the life of the loan.
Dealerships have a buy rate with each lender, which represents the minimum rate the bank or credit union will accept. The dealer can mark that rate by an agreed-upon amount, usually 2.5% points or less. This is called the sell rate, and it’s what the dealer may present to you.
While it might not seem like much, an additional 2.5% can significantly add up over the life of a loan. For instance, if you borrow $25,000 over a 60-month term, a 2.5% finance commission would add up to $1,614. That is the profit the dealership would make on a 2.5% finance reserve.
The best way to prevent dealers from charging you a large commission is to shop for your own auto financing, where you interest rates are never marked up, before visiting the dealership. Get multiple online quotes and contact a few banks and credit unions. Once you get several financing rate quotes, take them to the dealership to see whether they can beat it. If they can, you should not even worry about whether they are charging a dealer reserve. Generally, the finance reserve will be less if they can beat your best rates.
You should also double-check the contract before signing, as some unethical dealers might extend the loan term or increase the interest rate in the agreement. While this is quite rare, it pays to be extra careful.
Other ways dealers increase profit on financing cars
Here are other ways dealerships generate income through financing deals.
Extended warranty and add-ons
Besides interest rate mark-ups, car dealers usually offer extended warranties and add-ons to buyers. These include gap insurance, maintenance packages, and protection plans, which come with a price tag that contributes to the dealer’s profit. While these add-ons may be attractive to the buyer, it’s crucial to carefully consider their value and needs before making a purchase.
Manipulation of the trade-in value
Another way dealerships make money off a financed car is by manipulating the trade-in value of your current vehicle. While trading in a car lowers or eliminates the down payment, dealers set the price on what they paid for a used, trade-in car. They then use their own mechanics and resources to get the trade-in car in good condition.
At last, the car is sold at a considerable profit indirectly for the dealer to make money off financing. It’s important to research the market value of your trade-in vehicle before to ensure you are getting a fair deal.
Dealer reserve sharing
In some cases, car dealerships can share a percentage of the dealer reserve with the lender, bank, or credit union offering the loan. This is known as dealer reserve sharing, and it allows dealerships to maintain a good relationship with lenders. It also helps the dealer secure better financing options for their customers. While this might lower the immediate profit of the dealer, it can lead to long-term benefits by allowing access to favorable lending terms.
Service and maintenance
Car dealerships can also generate income through their service and maintenance departments. When customers bring their car for regular repairs and maintenance, dealers charge for the services offered. These charges highly contribute to the total revenue of the dealer and help reduce any potential losses incurred through car financing deals.
Dealer financing incentives
Car manufacturers and lenders usually offer incentives to dealerships to promote their financing services. These incentives can be in the form of rebates, bonuses, or other financial offers. Dealerships can benefit from these incentives by offering provider-backed financing, which can improve their overall income.
Pros and cons of dealership-assisted financing
Taking a dealer-arranged auto loan has pros and cons. Whether it’s a great deal depends on several factors, like your creditworthiness and whether there are incentives from auto manufacturers that require you to use their financing companies.
Pros of dealer-assisted financing
Financing is all combined into a single transaction - If you choose to use dealer-arranged financing, they will combine the car’s purchase price, your monthly payment, and the value of your trade-in car into one transaction. This transaction is usually centered on a monthly payment.
It’s easy - Since you can get everything except the right auto insurance in one stop, applying for financing right at the dealership makes car buying easy and quick. You will not need to visit various banks, credit unions, or their websites. Instead, you just need to fill out one application, and the dealer will take it from there.
You will also not need to pick up a check from your bank when you opt for in-house financing at dealerships. The dealer will take care of all the funding paperwork.
You can leverage automaker financing deals - If a model is on the way or a car isn’t selling as quickly as a manufacturer expects, they will often offer unique incentives to dealers and buyers to keep up with the sales pace. In most cases, buyers must use the manufacturer’s affiliated finance company to leverage these low-interest and cash-back car deals. Only auto dealers can access these companies, meaning you will have to get your loan at the dealership to acquire them.
You can negotiate terms - Dealership financing may offer less flexibility than direct financing, but you can negotiate interest rates or various loan terms. The dealership can agree to charge less markup fee, meaning the loan will be more affordable.
Cons of dealer-assisted financing
Less flexibility for lender options - If you opt for dealership financing, you will only get offers from the banks or credit unions associated with the dealer. This may lead to less flexibility in loan interest rates and terms than when you borrow directly from a lender.
Potential for less transparency - Since auto dealers are in business and would want to profit from the deal, they might be less transparent about the markup interest rate. You might also not have sufficient time to thoroughly research all the incentives available.
Higher interest rates - The dealer may add a markup to the purchase rate offered by the associated bank or credit union. That means you might end up paying a little higher interest rate than if you borrow directly through a financial institution.
Final thought: Is financing with a dealership a good idea?
Provided you have compared multiple offers from different lenders, banks, and credit unions, financing with a dealership can be a good idea. Comparing various quotes gives you an idea of what kind of interest you are likely to get, and this can prevent the dealer from offering higher rates and fees on the loan. It also gives you some advantage when negotiating the car price.