How Much Money Do Dealers Make on Car Financing?
Dealerships work with several banks and they simply arrange the financing for you. Just like any service where there's a middleman, you can expect to pay some sort of commission.
Dealers make their commission through what is known as a finance reserve. This is an extra percentage added to your interest rate - usually 1 to 3%.
For example, a dealer may be able to get you financed at a 5% interest rate through one of their lending partners. This is called the "buy rate" - the rate at which the bank is willing to loan you the money.
The dealer will keep this figure hidden from you. What they will show you is the "sell rate", the interest rate that includes their commission. In this case, it may be 7%.
This 2% difference is where the dealer makes their money when they arrange the financing for you.
It may not seem like much, but an additional 2% interest can really add up over the life of a loan. For example, if you were borrowing $25,000 over a 60 month term, a 2% finance commission would come out to $1,291. That is the profit the dealer would make on a 2% finance reserve.
Many states and lending institutions have put a cap on the maximum interest rate a dealer can charge for arranging financing. The cap is usually 2.5%, but dealers can and do charge higher amounts.
A 5% interest hike on a $25,000 loan over 60 months equals $3,306 in profit for the dealership.
You can see how car financing can be a huge profit generator for any dealership. So how do you prevent them from charging you a large commission when arranging financing?
Your best defense is to shop for your own car financing before going to the dealership. Get some online quotes and also call a few banks and credit unions.
Once you get your own financing rate quotes, you can take that to the dealership and see if they can beat it. If they can, you shouldn't even worry about whether they're charging you a finance reserve - it will be minimal if they're able to beat your best rates.
You can also ask to see the lender approval, but many dealerships will be hesitant to show you the documents, so again, your best bet is to arrange financing on your own, then have the dealer compete to try to beat it.
My Recommendation for Car ShoppersTrueCar No-Haggle, CarsDirect, and NADAGuides are the quickest way to see the lowest car prices in your area. These sites show you no-haggle prices from dealers closest to you - and the deals are usually really good. This should be the first step you take when negotiating your car price. Follow this up with my checklist to make sure you squeeze out every last bit of savings.
- Gregg Fidan
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