Many people are under the assumption that car dealers only make money on the sale price of a vehicle. If this were true, it would make buying a car much simpler and getting a better auto loan rate a lot easier. It’s not the case however, and very few people that are outside of the car business or have never worked in that industry are aware of exactly how it works. The fact is that the sale price of the vehicle only amounts to a small part of the total picture.
When you go into a car dealership to buy a car, the sale price primarily covers the cost of the car, the cost of dealership overhead and the salespersons commission. That is called front end profit. Where the real money is made, is in what is called back end profit.
When a dealership takes your credit application and sends it to a few lenders, the lenders send a response that either approves or denies your application. If your application is denied there is generally a good clear answer as to why, which helps the dealer to know in the future what to look for prior to submitting applications to that particular company. If your application is approved, there is a few different factors that are involved. There is be amount allowed for financing, a percentage of that amount that the creditor will allow for an extended warranty, and the number of percentage points that the dealer can add to the loan. These percentage points, otherwise known as dealer add-on rate, are where a lot of hidden money is made in car dealerships. To elaborate on this, let’s have a simple example.
Let’s say that the creditor or loan company, approves your loan at an interest rate of 10%. That is a reasonable auto loan rate for someone that has had some bumps in the road on their credit report. If the approval comes back allowing the dealer a dealer add-on rate, of 3%, then the dealer can add 1%, 2% or 3% to your auto loan rate. The difference between paying 10% or 13% on your car loan, can make a substantial difference in the amount of your car payment. In many cases, this can add $100 or more to your monthly car payment. The additional amount that you pay each month because of the dealer add-on rate, is divided between the car dealership and the finance company.
So what happens if you trade your car before your car is paid off? Generally a dealership is only charged back if you trade your vehicle within the first year. That is why the dealership is not advanced the full amount of the extra profit that is made on the dealer add-on rate.
How can you avoid this? With the veil of secrecy being held closed so tight in car dealerships, regarding this issue, the public really has no way of even knowing what their true interest rate is when they are approved. The only way to avoid this is to seek financing outside of a car dealership and even then similar principles operate with bank loan officers. One of the best ways of avoiding this is comparing auto loan rate quotes from multiple companies, or using a service that uses the best rate for you.