Be Careful When Arranging Financing Through a Dealership
If you’re like many people when shopping for a car, you might be focusing on the wrong thing when buying your next vehicle. In fact, dealerships don’t make the majority of their money selling vehicles anymore. Rather, they make their money by arranging financing for that new shiny car and selling you extended protection products, like GAP, a vehicle service contract, or a maintenance plan. That’s why it is terribly important to learn what to watch out for when arranging financing through a dealership.
It is always a good idea to shop rates at your local bank or credit union before agreeing on vehicle financing through a dealership to ensure that you get the best possible rate. Regardless of where you end up receiving your money from, this guide will show you what to watch out for when arranging your financing through a dealership.
First, we will look at the phrase “dealer markup” and discuss what it is, if its legal, and what are some commonly associated terms. Next, we will see some real-life examples of how much a financing rate can negatively effect a payment. And finally, I’ll leave you with a few easy tips to save money the next time you need to finance a vehicle through a dealership.
What is Dealer Markup on a Loan?
Dealer markup is an under-discussed, often misunderstood term in the car business and it’s a dealer’s best friend. Dealer markup is the difference between the “buy rate” and the “sell rate” of the financing for a car loan. Don’t worry if you don’t know what that means – just keep reading.
Before we discuss this topic in too much detail, it is important to go over the basics for vehicle financing through a dealership. The dealership will pull your credit, which allows them to see what lenders you have a relationship with and the overall strength of your credit profile. Next, they will submit your loan application to various lenders, such as 3-5 banks and credit unions. Finally, they select a lender and present you with payment options.
Sounds easy, right? However, dealers can make a lot of money between the last two steps. If a dealer gets more than one approval, they might present you with the one that is best for them, not the one that gets you the lowest rate and payment. Dealers can have a set quota of the number of deals that they need to send a lender in a given month. If the dealer hits this quota, it can mean big money for the dealership. For you, it means a worse approval – and a higher payment.
Now, let’s actually dive into what markup is when financing through a dealership. When a bank or credit union approves your loan application, they will respond with a “buy rate”. This is the rate that they will purchase the contract at, and the minimum rate that the dealership is allowed to charge you. If your approval is with a buy rate of 3.89% and the dealership gives you the buy rate, then your payment will be based on an interest rate of 3.89%.
However, it is very common for a dealership to mark up the buy rate to the “sell rate” which is what you see listed on the contract. The maximum markup can vary by state, but it is 2.00% where I am located in North Carolina. This means that if the bank “bought” your loan at 3.89%, the dealership could offer you up to 5.89% on your contract. This extra interest that you will pay over the life of the loan is shared between the bank and the dealership.
This dealership markup on financing contracts is one of the top things to watch out for when arranging financing through a dealership. As we will see in the next section, this small item can drastically increase your monthly payment and the profit of the dealership. Be sure to not get tunnel vision by focusing too much on the purchase price of the vehicle, but instead focus on all areas of negotiation when purchasing your next vehicle.
How Much Can Dealer Markup Affect My Payment?
Your interest rate might not seem like a big deal on the surface, but it is incredibly important to the total cost of the vehicle over the course of the loan. For example, let’s look at how much more you will pay if you are buying a $35,000 car and financing the vehicle for 72 months. If you received the buy rate in the Finance and Insurance (F&I) office, you would pay almost $4,300 in interest over the course of the loan and your payment would be around $545 a month.
However, what would happen if the F&I manager decided to mark up your rate to 5.89%? First, your payment would increase to $578 a month and the total amount of interest paid would be $6,632. This is an extra $33 in interest per month and $2,332 in interest over the course of the loan. Next, the dealership would receive a portion of this extra interest immediately when the loan is funded. The normal portion of this interest sharing is 60-80% of the extra interest. This means that the dealership just made an additional $1,632 off of marking up your interest rate on your car loan.
What Can I Do About Dealer Markup?
The best thing that you can do to protect yourself when shopping for your next vehicle is to be informed. You should have a good idea of your credit score before walking into a dealership. You should also know what interest rate you can get by using your local bank or credit union.
If you choose financing through a dealership, there is nothing wrong with asking questions about the rate. Although the finance manager might be somewhat taken aback, it just shows that you are an informed consumer. Ask the finance manager about what lenders they sent you to, if that is the best approval, and if they are marking up the rate.
Don’t be surprised if the finance manager pushes back or seems reluctant to discuss this with you in much detail, but keep pushing. Doing so can save you thousands of dollars of interest over the course of the loan. And, as always, please don’t hesitate to reach out to me if I can be of assistance the next time you are shopping for your next new vehicle.
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