For the rest of this guide, I am assuming that you have found a good car for a good price, had it checked out with a mechanic, asked the dealer about the prior use, condition and history of the car, particularly if it is a used car, and that you are ready to talk about financing.
Most people finance the purchase of cars but a lot of people do not know how financing really works. In the 1970s, dealers began to have a separate department for finance and insurance. In the industry, this department is referred to as the F&I department. Banks and finance companies agree to pay dealers commissions for processing contracts and percentages of interest rate markups. In addition, dealers earn additional profit by selling extras such as credit life, GAP insurance, window-etch security, warranties or other products. As the profit margins on new cars shrunk with more competition and more sophisticated consumers, dealers have been forced to focus more on F&I to make a profit.
Many dealers now make more money in their finance and insurance department than the front end profit, i.e., the difference between what they buy and sell cars. For many dealers, they are no longer in the car selling business as much as they are in the contract and extras selling business. The better your contract looks to a lender, the more the lender will pay for it. If you pay a higher interest rate than is warranted for your credit history, then the lender expects to receive more profit from its risk and will pay more for this contract. Let me give you an example. If the consumer would qualify for a “buy rate" of 7%, but the finance manager can write the loan for 8%, the bank will pay the dealer a “reserve fee", which is a percentage of the amount financed. Reserve fees can range from one-half a percent to six percent of the amount financed. The higher the interest rate, the bigger the kickback. The practice of charging a yield spread premium is subject to criticism for many reasons. Indeed, many finance companies have settled class action lawsuits alleging that they benefitted from a practice of charging much higher yield spread premiums to minorities than other consumers.
With some of this information in mind, you know you have incentive to minimize the amount of finance charges or interest you pay in any transaction because you will rarely, if ever, be given the “best rate available." Before going to the dealer, it would be good to check with your bank or credit union to find out what terms would be offered if you were to finance a car. Oftentimes, the bank or credit union will have different rates depending on the year of the car. If you can get this information ahead of time, you should be able to compare what the bank or credit union offered to what the dealer is offering and choose the option that best suits you whether that is a lower interest rate or a lower payment.
Most consumers do not realize it but they have the option to actually compare a retail installment sale contract from one dealer to a retail installment sale contract from another dealer. In order to do this, however, it is important that you do not sign a “purchase contract," “buyer’s order" or something that says you are buying the car and will work out financing options later. If you are financing the car, these documents should not be required but I know of no dealer which does not ask the customer to execute these as part of the transaction even when a consumer is financing. If you sign a buyer’s order, you are essentially telling the dealer that the car is being purchased but that you will try to work out the financing with the dealer or someone else. If you insist that you do not want to sign one but you want a retail installment sale contract so that you can compare what the dealer is offering to that of other dealers, you may get a run around that “we don’t do that" or something to that effect. If the dealer wants your business, they can do that. Indeed, the Truth in Lending Act says that a financing transaction is not completed until the consumer signs the retail installment sale contract and the law requires the dealer to provide you with a copy of that contract before you sign it even if you give it back to the dealer. Ideally, you could fax other dealers a copy of your unsigned retail installment sale contract and ask other dealers if they could meet or beat what was offered.
A few words about extras. I am not going to declare that none of the extras are worth purchasing. It depends on your circumstances but you should know that the dealers make a lot of profit from these extras. Some general words of advice are to consider a manufacturer’s extended warranty and an extended warranty from a third party carefully. Sometimes there is a reason why there is such a big discount in price. Also, look at the language of the extended warranty for exclusions. Did you know that if you do not keep receipts for all your oil changes done in accordance with the warranty or owner’s manual, some warranty companies may suggest the warranty is invalid. I have seen it happen with sludge claims.
Did you know that some Gap Insurance (insurance to cover the difference between what the car is worth and what you owe on it) only insures 125% of the fair market value even if you purchased the car for more. For example, sometimes a purchaser finances much more if there is negative equity in a trade-in car meaning that the trade-in was worth less than was owed on it. Oftentimes you can get a lot more life insurance bang for the buck paying for it separately or increasing your policy rather than buying life insurance solely to cover the amount owed under your financing contract if you should die. Window-etch has proven to be very profitable to dealers.
The bottom line is you should avoid paying for extras unless you truly want them. Sometimes a dealer will quote a monthly payment and ask if that is doable rather than working with the price of the car backwards to figure out a monthly payment. Some finance and insurance managers are taught to load up on the extras and explain to consumers that the reasonable monthly payment includes these extras at no additional charge when, in fact, the monthly payment would be a lot less if the monthly payment was calculated without all the extras. This practice is known as payment packing and has been declared illegal by some attorney generals.
Finally, you should avoid paying a closing and administrative fee unless that was agreed to up front. If it is something that is only added in the finance department and not disclosed in the advertisement or in negotiations, this is a form of bait & switch and you should not pay it. There is nothing wrong with making a profit but I believe it is immoral to change the terms of the agreement after someone has invested considerable time and a deal has been reached. When I have challenged this practice personally, dealers often agree to back out the amount of the fee from the purchase price if they can add it back as a fee. I consented because the net purchase price remained the same. I suspect they want to retain the ability to say that everyone who does business with the dealer is charged this fee. I hope you get some bang for your buck!
Disclaimer: The above Article is intended to give you, the consumer, insight into various legal topics. This information is not intended as legal advice, but rather helpful topical information.
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