Car Salesman Confidential: Gorillas In The Mist

Every car deal has two 800-pound gorillas in it . . . but no one talks about them. Instead, all anybody wants to talk about is that little monkey sitting off to one side named Discount.

What are these 800-pound gorillas called? Well, one is called Rate, and the other is called Term. And their joy in life is tag-teaming your bank account.

I’ve seen people shop for months to find what they think is the best price. I’ve seen people come into my dealership and fight for three hours for an additional $500 off. I’ve seen people “blow out” — leave in a huff — over $1.25 in payments (that’s 4 cents a day, folks). And then I’ve seen the very same people walk into F&I (Finance & Insurance), and agree to financing that costs them thousands. Why? Because they didn’t know where the real money in a car deal is.

By far the biggest amount of money on the table in any car deal is what is made in the F&I office. I’m not just talking about the products they sell; I’m talking about the cost of borrowing money. If your rate is high and your term is long, you can wind up paying many, many times what you saved in discounts.

Let‘s start with the interest rate. Say you’re buying a $27,000 car. You ask for $4,000 off, but the dealer says no. You compromise and settle for $2,000 off, ending up with a final price of $25,000. (Obviously, I’m greatly simplifying these numbers.) Now let’s take a look at the effect of the interest rate on your $25,000:

Amount Financed	Term	Interest Rate	Total Amount Paid
$25,000	5 yrs. / 60 months	0.0	$25,000.00
$25,000	5 yrs. / 60 months	0.9	$25,576.20
$25,000	5 yrs. / 60 months	1.9	$26,226.00
$25,000	5 yrs. / 60 months	2.9	$26,886.60
$25,000	5 yrs. / 60 months	4.9	$28,238.40
$25,000	5 yrs. / 60 months	6.9	$29,631.00
$25,000	5 yrs. / 60 months	8.9	$31,065.00

The first thing to notice is that there is a swing of $6,065 between zero percent and 8.9 percent. So if Joe Schmo has poor credit and the best he can qualify for is 8.9 percent, Joe will be paying a lot more for his car than the guy who qualifies for 0 percent. And if Joe has really bad credit — like, car salesman bad — he might end up with a rate around 14.9 percent. In that case he’s paying $35,606.40 for his $25,000 car– or $10,606.40 more than the person with excellent credit. Ouch.

Now, let me stop here and say this: If the best rate Joe qualifies for is 14.9 percent, that isn’t the dealership’s fault. Maybe that rate is the result of Joe’s poor choices. Or Joe may have lost his job and been unable to find work, or was hit with a serious illness. Who knows? People have bad credit for many reasons, and having bad credit doesn’t mean you’re a bad person. It just means you won’t qualify for a better rate until your credit history improves.

But car dealers normally don’t try to jack someone up eight to 14 points. A person with a 750 credit score usually knows they have good credit, and knows what they qualify for (or close to it). So normally a dealer may try to hold two or three points on a qualified buyer. Let’s say the lender tells the dealership they’ll buy the customer at 2.9 percent (the “Buy Rate”), but the dealer wants to make a little money so they mark up the Buy Rate two points and list you at 4.9 percent. If you take it, you just left $1351.80 on the table. Not a huge amount, but that’s three car payments. Or one house payment (for some people). Yet people will fight a salesman over $100 on the “front end” (the price of the car), and give up $1350 on the “back end” (financing). Doesn’t make sense, does it?

Let me stop again and say there’s nothing wrong with the dealership making money off of financing. All lenders do. And they should make money off financing. They’re providing you with a valuable service — they’re loaning you $25,000 for five years — and you should be willing to pay for that service. If you think the bank or the credit union who approved you at 1.9 percent isn’t making money on your loan you’re kidding yourself. They make money on every loan, or they wouldn’t be in business for very long, even credit unions. But a car dealership or a lender shouldn’t be allowed to make an excessive amount of money on a loan. How you determine what’s “excessive” is up to you.

That was Rate. But remember, these gorillas like to work in tandem. So let’s mix metaphors a bit and look at the other wrestling champ waiting to hit you with a steel chair and piledriver you: Term. How long should you finance a car? In the 1960s, the average car loan was 24 months, or two years. Five-year loans were unheard of. But today, most people finance vehicles for five to six years. The reason is simple: It lowers your payment. But in the end you pay a lot more for your car. Let’s take a look at what adding just one year to a car loan will do to you:

Amount Financed	Term	Interest Rate	Total Amount Paid
$25,000	6 yrs. / 72 months	0	$25,000.00
$25,000	6 yrs. / 72 months	1.9	$26,471.52
$25,000	6 yrs. / 72 months	2.9	$27,267.84
$25,000	6 yrs. / 72 months	4.9	$28,905.12
$25,000	6 yrs. / 72 months	6.9	$30,602.16
$25,000	6 yrs. / 72 months	8.9	$32,356.80

Here’s how it works. Let’s say you’re trying to reach a payment of $400 a month. You and your spouse have looked at your budget and decided this is the most you’re willing to pay. Of course, you’d really like to be $350 or less, but you haven’t found a car you like for that amount. So you’ve reluctantly accepted the fact that you might have to go as high as $400. (Of course, you don’t tell the salesman that!) But you’ve been shopping for six weeks. You’ve visited 14 different dealerships in four different states, spent more time doing on line “research” than it took Alexander Graham Bell to invent the telephone, and beaten the poor car salesman over the head with your TrueCar stick so hard it actually broke off in your hands. You know you’re looking at a fantastic deal — but you’re still at $459.29 a month, which is $60 more than your max. What do you do? The salesman humbly suggests 72 months. That will cost you a point in rate (typically the longer the term the higher the rate), but it puts your payment at $401.46. Hell, you can do that. Give me that pen!

But what have you really done? What you’ve done is, you’ve just agreed to pay $1347.72 more for the car than you would have paid if you financed for 60 months. Not only that, you’ve also just guaranteed – guaranteed — that you will be “upside down” when you decide to trade it in 4 or 5 years from now. Is this a bad thing? Not necessarily. For many people, their household budgets are so tight that having an extra $58 in their pocket every month is more important than spending an extra $1347 over the next six years. So I’m not saying don’t do it. I’m saying know what you are doing.

So, like Randy Savage jumping off the top rope to deliver a devastating elbow drop, or Brock Lesnar slamming you into the ground with a suplex, these are the brutes waiting to stomp you into the mat whenever you buy a car. The best way to defeat them is one, start building better credit now, and two, don’t just concentrate on the discount. Think about interest rate and the length of the loan, too. And if you qualify for a spectacular rate like 0 percent at 72 months, don’t bother asking for a huge discount as well. You can get one or the other, but not both.

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