When you’re buying a car, you probably don’t think about how personally invested your dealer is in the purchase. We all know they can sometimes come off as pushy and try to sell you financing and insurance, but why is that so?
Do car dealers make money off financing and other purchases?
If you’re interested in the inner workings of the dealership industry, let’s talk about it, because we’ve got a lot to say!
Do Car Dealers Make Money Off Financing?
The short answer is yes, dealerships that finance your vehicle make money from the service. But it’s not just financing that stuffs a dealer’s pockets, but many other things as well.
So how do dealerships make money? Here are a few noteworthy ways:
New Car Sales
Of course, one of the biggest moneymakers for dealerships is selling new cars. Now you know why the salesman is talking about the car you’re eyeing like it’s the most exceptional vehicle in the world – the more new cars they sell, the more money they make.
You can check out the best car loans in Canada to ensure a transparent service.
But remember, each vehicle has what’s called a “holdback.” Essentially, this is a percentage of the manufacturer’s suggested retail price (MSRP) that the dealership gets to keep as profit. Additionally, sales consultants might also receive volume bonuses for selling a set number of cars per month, called “stair-step incentives”.
Used Car Sales
Just like new cars, dealerships finance and make a profit off used cars as well. Usually, the dealer buys the car at an auction, marks up the price, and sells it to an interested buyer. However, the difference in selling used cars is that the dealer typically doesn’t have a holdback, as the car doesn’t come from the manufacturer directly.
Additionally, since most used vehicles don’t come with a warranty, you might be paying for regular repairs as well, which is another essential income source for the dealership. If you’re not sure about the price of old cars, head over to Kelly Blue Book and discover the “ballpark” prices before you buy.
Financing and Interest
As you probably know, car dealerships finance vehicles at a higher interest rate. Admittedly, this is how they make the most money. Namely, dealers have a “buy rate,” which is the rate a bank or credit union will accept for a loan. Then, the dealer marks up the rate by a certain amount, up to 2.5%, and then sells you a higher rate, i.e. the “sell rate.”
As a result, if the dealer secured a loan with 5% interest, they’ll sell it to you for 7%. Although this might not seem like much, even a 2% increase can add up over time, depending on the life of your loan. If you want to learn more, read our detailed guide on dealer financing.
You can also check out how refinancing a car loan works at a dealership!
Repairs and Parts
Since you’ve bought a car from a dealership, you’re probably going back there to get it serviced, which brings in extra money for the facility. Namely, whenever you need a repair, new tires, or have a faulty engine, your dealer earns money.
Of course, this is nothing surprising since the dealership is providing you with an additional service. And if you need new parts, you can get them there, too, and not have to worry about chasing the manufacturer.
At the final stage of purchasing your new car, you’ll encounter a wide range of extra-cost items that the dealer will try to sell you. Some of these options are worth considering, such as rust protection, extended warranty plans, lease protection, paint and interior protection, or accessories.
However, the dealer might try to get a fee for things that aren’t mandatory, such as documentation, nitrogen tire packages, wheel locks, window etching, maintenance plans, and wheel and tire protection. As these add-ons are often overpriced, a big chunk of the cost goes to the dealership.
So, do car dealers make money off financing?
Yes, but they do so from other things, as well. In fact, new and used car sales, repairs and parts, and add-on fees provide a significant increase in the dealership’s revenue. Therefore, the next time you’re at a dealership, keep this in mind and be sure to read the fine print before you agree to anything!
Since the dealer is essentially the middleman between you and the lender, they will personally benefit from securing your loan. Namely, the lender will give the dealer a rate called the “buy rate,” for which they will approve the loan, for example – 3%. Then, the dealer tells you another rate for the loan, i.e. the “sell rate,” which can be 5%. That 2% difference is how car dealerships finance work and maintain the facility.
Dealers want you to use their financing because they’ll get a cut from the money you pay for your interest rates.
If you agreed to finance your vehicle through the dealership, they’ll handle the financials. In fact, for a trade-in, the dealership will usually pay off your old car loan. However, you might still have to pay off some of your balance.
Financing with a dealership is a good idea if your credit score could use a little work. Also, if you want to obtain a loan through a buy here, pay here dealership of a franchise dealership, there will be less risk involved than when you’re using the dealer as a middleman. However, if you can qualify for an outside loan, we recommend sticking with that as it offers better rates more often than not.