Car dealerships often offer financing when you purchase a vehicle, which simplifies and centralizes the car-buying process for consumers. When using financing through a dealership, buyers just have to pick the car they want, have the down payment in hand, and let the dealership do the legwork to make it happen.
What many buyers don’t realize is that dealerships make money off of financing. In fact, it’s a huge area of profit. Here’s how it works.
Traditional means dealerships make money off of financing
Dealerships are not the entities actually extending credit to their buyers, except in some cases of in-house financing for used car dealerships. A dealer instead negotiates financing terms on behalf of a client, using your credit score and down payment amount as guides. The dealer pulls your credit score, and then contacts outside lenders to strike a deal.
What the dealer negotiates with lenders is the interest rate they pay, not what the end user, or car buyer, pays. This provides the dealership an opportunity to mark up the interest rate ultimately offered to the client and make money off of financing. This doesn’t amount to much of a profit in the beginning, but it adds up over time.
Let’s say a dealership negotiates financing for $30,000 with 3.5% over five years. This amounts to $2,745 in interest paid. The dealership doesn’t offer the buyer 3.5% but instead puts a 5.0% interest rate on the table, which amounts to $3,968 in interest paid. This system allows the dealership to make $1,223 off of financing in this example
How dealerships make money off of financing with 0% interest
Sometimes, dealerships advertise 0% interest. While it may seem impossible for dealerships to make money off of financing in this case, it happens. In a 0% financing deal, dealerships don’t make money off of the interest, but they do make money off of the sale of the car over time.
Dealerships use the 0% interest marketing strategy to boost sales when people are less likely to buy cars. The strategy gets customers in the door, so to speak. Then, the no-interest perk can entice consumers to purchase models that don’t sell well or clear out other stale inventory.
Other ways dealerships boost profits on financed cars
Add-ons like gap insurance and others present further opportunities for dealerships to make money off of financing. Gap insurance provides coverage in the initial stages of financing when the payoff amount exceeds the value of the car. Extended warranties and service plans are other opportunities for dealership profit. These add-ons increase the amount being financed and even lock consumers into having the car serviced on site.
The last way dealerships make money off of financed cars is on trade-ins. While trading in a car reduces or eliminates the down payment, dealerships set the price on what they pay for the used, trade-in car. Then, the dealership uses its own mechanics and resources to get the trade-in car in good condition. Finally, the car is sold at a hefty profit for an indirect means for the dealership to make money off of financing.