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How Do Wholesale Car Dealers Make Money on Financing?

Do you want to add financing option to your car dealership business If YES, here is a full illustration of how wholesale car dealers make money on financing and how you too can. No business can exit unless the business makes consistent profit. Be it a retail outlet, a restaurant or a car dealership. A lot of people think that car dealerships make the most income from the rows of shiny cars they sell. However, this is far from the truth.

According to the most recent data from the National Automobile Dealers Association (NADA), the new vehicle department of a car dealership accounts for about 30 percent of a dealership’s gross profits. In addition to car sales, that figure also reflects profits from finance and insurance (F&I) products sold on new cars. That means such things as gap insurance, alarm systems and extended warranties.

In most car dealerships, about 26 percent of their profit come from the sale of used vehicles according to data gathered by the NADA. In addition to car sales, the figure also reflects profits from F&I products sold on used cars. Another main source of profit for car dealerships come from the service and parts department, which accounts for 44 percent of the dealership’s gross profits, according to NADA.

A lot of car shoppers are usually cautious when they go to a dealership to buy cars because they do not know what they’re going to pay for the product. Shoppers don’t expect to negotiate the cost of a biscuit with a salesperson at the supermarket.

However, they will be expected to negotiate and haggle car process. You can better navigate some of the more complex purchase negotiations by understanding some of the financial aspects of the car selling business. Here are some examples.

8 Smart Ways Wholesale Car Dealers Make Money on Financing (Detailed Illustration)

1. New Cars (Dealer Holdbacks and Dealer Cash)

Car pricing can be a complex process. Some customers just take a look at the invoice price of a car and then make the assumption that that is what the dealership paid for it. This may even lead them to wonder how dealerships make their profit.

In addition, it is not uncommon during the process of negotiation with car dealers for them to complain that they are not making anything from the deal. More often than not, they are just trying to guilt you into paying a higher price. This is where two other sources of manufacturer money come into play.

2. Dealer holdback

This is a sum of money that the manufacture of the car pays to the car dealership after a car has been sold. Usually, the sum that is paid is about 2 to 3 percent of the invoice or the sticker price of the car. For instance, on a $40,000 car, a holdback represents $800 to $1,200. The dealer holdback allows car dealers to sell their cars at invoice price or sometimes even below invoice price and still make money.

Most manufacturers offer holdbacks to their brands’ dealers, but not all. You can check the holdback percentage before going shopping but don’t try to build it into your negotiations. Dealers consider this money off-limits for the purposes of price negotiation.

3. Dealer cash

Dealer cash comes into play at the end of a model year, when both the dealership and the manufacturer want to clear out even popular cars to make way for the incoming new vehicles.

4. The Role of Commissions

Usually, a car salesperson is paid on a commission basis (with or without a base salary). So in order for these salespersons to increase their monthly income and hit sales goals, they try to sell more cars. This creates a scenario where a buyer wants to buy the car at the lowest possible price to save money while the car salespersons wants the car to be sold at a higher price for better commission.

5. Used Cars (Trade-Ins and Purchases)

Even though used cars bring in little money for car dealerships, the trade-ins themselves can be a huge profit center for the dealer and dealers really need those used cars. According to NADA, 61 percent of a dealer’s used car inventory comes from trade-ins.

Used car are more profitable for car dealers than their new counterparts. For instance, there’s a $4,000 difference between the trade-in value of a 2010 Toyota Camry XLE — what the dealer would pay you for it — and its dealer retail price — what the dealer would sell it for.

Car dealers will tell you that they need to recondition used cars before they can sell them and this costs them money. However, the profit margin on a used car is usually more than a new car. NADA reports that at the average car dealership in 2012, net profit per new vehicle retailed was $111.

When they are being purchased by the customers, used cars can be tricky for shoppers because they can be a “blind negotiation”. The car shopper does not know how much the dealer paid for the used car and may find it very difficult to gauge its current market value. Only by researching the current market and comparing prices can you know the right price for a used car

6. Finance and Insurance

Financing and insurance is a very important source of income for car dealerships. According to NADA, nearly 37 percent of a dealership’s gross profit comes from the sale of F&I products and service contracts on new and used cars. And while the gross margin on the sale of new cars and trucks fell to 4.2 percent in 2012 from 4.6 percent in 2011, aftermarket income rose “because of increasing F&I and service contract dollars,” according to NADA.

The average profit on a new car from F&I products was $804 in 2011, according to a 2012 survey of 800 subscribers to F&I and Showroom magazine. With increased training for the F&I staff, that figure can go up to $1,200 per car, according to Zurich, a company that conducts F& sales training. In short, F&I sales are critical for a dealership’s success.

The dealership’s F&I manager is primarily there to present the dealership’s pitch for financing. It’s worth listening because sometimes the interest rates are lower. But you also should arrange independent financing first. Then you’ll be able to know for sure how good the deal is.

In addition to offering dealer financing, the F&I manager typically offers extended warranties, also known as extended service contracts. The pitch for extended service contracts appears to be a winning one with car buyers. In 2012, customers bought extended service contracts on 42 percent of new vehicles. That’s the highest rate in the past two decades, according to Automotive News, citing NADA data.

7. The Service Department

In times when the economy has been slow, service bays have kept many dealerships afloat. Every dealer knows that there is a high chance that a car buyer will bring the car back for regular servicing and even if the amount the dealership made from the initial sale of the car was not much, there’s the possibility of continued cash flow from a service relationship.

Commissions play a part in the service operation as well. Service advisers typically receive a commission on all the parts and services they sell. Again, the amount of sales pressure you’ll experience varies widely.

8. Add ons

Finally, a dealer will try to sell you add-ons, such as an extended warranty, gap insurance, or other accessories – adding another $750 to $2,000 to their bottom line.