Do Dealerships Make Money on Financing?

Buying a car often involves securing a loan. Understanding how car dealerships handle financing is important for buyers navigating this process. A clear grasp of the financing process helps consumers make informed decisions and manage the overall cost of their vehicle.

Understanding Dealership Financing Structures

Dealerships typically facilitate car loans through an indirect lending model, acting as an intermediary between the car buyer and various financial institutions. The dealership’s finance and insurance (F&I) department plays a central role in this process, connecting customers with potential lenders.

The F&I manager gathers a buyer’s financial information and submits it to multiple banks, credit unions, and captive finance companies associated with car manufacturers. These lenders then provide potential loan offers to the dealership, including an interest rate. The dealership then presents these financing options to the customer.

Dealerships often have established relationships with a network of lenders, which allows them to quickly secure various financing terms for different credit profiles. This widespread access to lenders can streamline the loan application process for the buyer. However, the dealership’s role as an intermediary also introduces potential avenues for revenue generation.

Dealership Revenue from Financing

Dealerships generate profit from financing through several distinct mechanisms, primarily by marking up the interest rate offered by the lender. When a lender approves a loan, they provide the dealership with a “buy rate,” which is the wholesale interest rate they are willing to accept for the loan. The dealership then has the discretion to offer the customer a higher “sell rate,” with the difference between the buy rate and the sell rate becoming the dealership’s profit. This markup can add a percentage point or more to the customer’s interest rate.

Beyond interest rate markups, dealerships also earn revenue from the sale of “backend products,” which are additional items bundled with the vehicle purchase and financed into the loan. These products include extended warranties, which provide coverage beyond the manufacturer’s warranty, and Guaranteed Asset Protection (GAP) insurance, which covers the difference between the vehicle’s value and the loan balance if the car is totaled or stolen. Other common backend products include service contracts, paint protection, fabric protection, and anti-theft devices.

These backend products often carry high profit margins for the dealership. For instance, an extended warranty or GAP insurance policy that costs the dealership a few hundred dollars might be sold to the customer for well over a thousand dollars. The cost of these products is typically rolled into the total loan amount, increasing the total amount financed.

Some lenders also provide volume incentives to dealerships for originating loans. These incentives contribute to the dealership’s profitability and encourage them to facilitate more loans through preferred lending partners.

Financing’s Effect on Car Purchases

The financing structure impacts the total cost a consumer pays for a vehicle. The interest rate applied to the loan directly determines the amount of interest paid over the loan term, which can add thousands of dollars to the overall expense.

The loan duration also plays a role in the total cost. While longer loan terms can result in lower monthly payments, they generally lead to more interest paid over the life of the loan. Conversely, shorter terms mean higher monthly payments but less total interest.

Focusing solely on the monthly payment can obscure the true cost of the vehicle and financing. A lower monthly payment achieved through a longer loan term or a higher interest rate can make a vehicle seem more affordable upfront. This approach can lead to overpayment in the long run.

Consumer Strategies for Car Financing

Securing a pre-approved loan from an external financial institution, such as a local bank or credit union, before visiting a dealership provides an advantage. This pre-approval establishes a benchmark interest rate against which any dealership offer can be compared. It empowers the buyer with a clear understanding of competitive rates, allowing them to negotiate more effectively.

Consumers should actively negotiate the interest rate offered by the dealership. By referencing a pre-approved rate or demonstrating knowledge of prevailing market rates, buyers can encourage the dealership to reduce their markup. This negotiation can lead to a lower interest rate, reducing the total cost of the loan.

It is advisable to negotiate the vehicle’s purchase price and the financing terms as two separate transactions. First, focus on agreeing on the lowest possible price for the car itself. Once the vehicle price is finalized, then shift attention to the financing terms, including the interest rate and any additional products. This separation prevents the dealership from obscuring a higher car price with seemingly attractive financing, or vice versa.

Buyers should scrutinize all backend products offered by the dealership, understanding their necessity and true cost before agreeing to them. These products, such as extended warranties or GAP insurance, are often high-profit items for the dealership. Consumers can often purchase similar coverage from third parties at a lower price. Finally, before signing any documents, understand all loan terms, including the total amount financed, the annual percentage rate (APR), and any associated fees.