There are few purchases we agonize over more than buying a car. For most of us, buying a big-ticket item like a car is a huge deal, so nobody should fault us for trying to squeeze the best deal possible out of the auto dealer. The problem is that when it comes to negotiating the best possible price on a new car, we are often barking up the wrong tree.
Why Sneaky Car Deals Exist
In the last 10 years, car dealers had an average profit margin of 2%. In 2008, they barely managed to break even. Things picked up a little in 2012 with profit margins peaking at 3.8 percent, according to a report by financial information company, Sageworks. Compare that with the average profit margin of other industries, such as lawyers: 14.1%, accountants: 15.9%, physicians: 11.2% or investment advisors: 16.1%. I can’t remember the last time I asked my doctor or accountant for a discount or their “best offer,” but I wouldn’t dream of taking the first offer of a car dealer, even though I know they have paper thin profit margins to work with.
Nevertheless, before you shed a tear for poor auto dealers around the country, remember selling cars is only one on of the things auto dealers do to make a buck. Often, selling the actual vehicle is the least profitable part of the entire transaction.
Car dealers are businesses not charities so we shouldn’t fault them for trying to make a buck. However, some of the techniques sneaky car dealers use to make money push customers to spend their hard earned money on products and services they either don’t need or can find for a fraction of the price elsewhere.
1. Extended Warranties
Once customers have signed on the dotted line for a new vehicle, their guard is down. They are excited about their new car and are in the right frame of mind to invest money in protecting it for many years to come. A typical manufacturer’s warranty will cover you for parts and labor for up to 30,000 miles. Extended warranties provide peace of mind by stretching that protection, but for a price.
It is not that extended warranties are necessarily a bad idea. If you plan to keep your car until the wheels drop off, you probably should invest in a premium warranty. On the other hand, it may be a waste of money if you plan to sell it within a few years. In any case, shop around before buying an extended warranty at a car dealer. Car dealers are usually just middle men for manufacturers and add markups of up to 100% for their trouble.
2. Financing the Sale
Offering cash no longer gives you leverage when haggling for a better price on a vehicle. Dealerships actually prefer customers who require financing because they often make more on the loan than on the sale. Financing is such a good business for car dealers that they are sometimes willing to sell a vehicle “at cost” if they can get customers to finance the purchase through their in-house finance and insurance department. They sell this as a convenient service that saves time and hassle.
Again, dealers usually act as middlemen, sending credit applications on behalf of the customer to several lenders. Financing only represents a small part of a car dealer’s revenue, the high markups on loans and leases account for up to 20% of a dealer’s profit. To be fair, because car dealers generate a high-volume of loans for financing companies, they can often negotiate favorable terms for buyers. The key is to contact your bank and find out what the best terms they can pre-approve you for are, and then compare their best offer with what the car dealer offers you.
3. Yo-Yo Financing
One particularly sneaky technique that only the most unscrupulous car dealers practice is yo-yo financing, also known as hot-rolling. The trick consists in selling a car on the basis of a particular auto loan that is then mysteriously “revoked” by the financing institution for some undisclosed reason. The unsuspecting customer is called to the office to renegotiate the financing, only this time the loans “available” are much less favorable than before. This tactic is particularly effective with customers with bad to average credit.
4. Overlapping Insurance
Insurance and finance are usually handled by the same car sales department. The Finance & Insurance salesperson makes a living off commissions, so some healthy skepticism when checking out insurance quotes is warranted. Some car dealers — particularly the large ones with franchises throughout the country — do have some clout with insurance companies and may be able to negotiate preferential rates on your behalf.
The problem is that a skillful salesperson may also get you to sign for coverage you don’t need or that overlaps with coverage you already have from other insurance policies. For instance, a car insurance salesperson worth his salt is going to offer you a wide variety of insurance products, such as credit life insurance, accident and health insurance and gap insurance – insurance to cover the difference between the current value of your car and the balance on your auto loan.
Consider what coverage you need before you set a foot on a car dealership and compare prices offered by other insurance companies or their brokers, before purchasing any insurance from an auto dealer.
5. Dealer’s Discounts/Bonuses
Dealers keep the pricing of vehicles unclear to give customers the feeling that they are getting a better deal than they actually are. Some dealers present the manufactures suggested retail price (MSRP) as the bottom line price of a vehicle.
Savvy buyers know the MSRP includes a 5 to 10 percent markup on the dealer’s invoice, which allows a lot of room for negotiation. On top of the basic markup on the dealers invoice, manufacturers also give dealers an added bonus called a dealer holdback. The holdback is used to help with cash flow and pay for advertising costs. It is also a revenue source dealers don’t have to share with sales personnel through commissions.
The methods discussed above are, with the exception of yo-yo financing, legitimate ways for car dealers to make a little extra profit. What makes car salesmen sneaky is that they present many of the above options as unavoidable fixed costs the buyer has little or no control over. You might haggle for hours over the price of the car but then gladly take whatever interest rate and insurance quote the F&I salesperson happens to come up with.
Our advice? It is much more useful to view buying a car as a series of multiple transactions. Not all of them need to be completed at the dealership and — with the exception of taxes — the price is always negotiable.
Photo: Fuzion Blog
Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.