FINANCIAL ADVICE | BUYING A car
How Car Dealers Make Their Money
Published May 9, 2019
- Higher margins for the dealer mean more room for you to negotiate the price down.
- Add-ons are one of the more lucrative parts of a car dealer’s business.
- Dealerships make a bulk of this money by securing financing from lenders at a certain interest rate and then selling it to customers at a higher rate.
For many people, buying a car at a dealership can be a nerve-wracking experience. Most people rarely negotiate the way you have to when buying a car, and no one wants to get ripped off. To get the best deal possible, it helps to know how car dealers make their money. That way you can spot the places where they might try to overcharge you and negotiate like a pro. Here’s a detailed look at how car dealers make their money and how you can use that information for your own gain.
Most people assume that dealerships make most of their money selling new cars. But that actually isn’t the most profitable part of a dealership’s business. The market for new cars is extremely competitive, which keeps prices relatively low (even though it might not feel that way to you). Sometimes a dealer may earn only a few hundred dollars selling a brand new car. For full transparency, you can ask the salesperson to show you the invoice price, which is what the dealer paid for the car. They aren’t required to do this (so ask nicely), but it can help you figure out if you’re getting a good deal.
It’s also important to note that dealerships and individual salespeople often make bonuses for hitting certain sales targets. So, if you go at the end of the month and they need one more sale to get their bonus, they may be willing to give you a better deal.
Although it may seem counterintuitive, given that used vehicles are less costly than new ones, dealers can actually make a much better profit margin selling used cars. That’s because they use the old reliable business strategy of buying the product for a low price and selling it at a much higher one. Higher margins for the dealer mean more room for you to negotiate the price down.
Add-ons & the Parts and Service Department
Add-ons are one of the more lucrative parts of a car dealer’s business. The expensive upgrades come with huge margins for the dealer, giving them every incentive to get you to buy them. In fact, sometimes dealers will outfit cars with add-ons so that if you find something on the lot that you like, you’re either forced to pay for the additions or try to find a different vehicle. While these upgrades can certainly add functionality, convenience, and value to the vehicle, you may be paying for more than you’re really getting.
While add-ons have high-profit margins, parts and service are where dealerships make most of their money. On average, the service department may account for over half of a dealership’s overall profits. In fact, car dealers sometimes joke that they only sell cars so they can make money servicing them.
Service advisers often work on commission, so they may recommend repairs or replacement parts before they’re truly needed, and the hours spent working on your car are padded for extra profit. You only buy a car once, but you may come in for service once a year or more. Dealerships count on this ongoing relationship to make their money, so they’ll do whatever they can to maximize profits.
Few people pay for a new car in cash because they can’t afford it, or it’s just impractical. Instead, most people use some form of financing, typically a standard auto loan. This is what the car dealerships are counting on. They know people need financing, and they’re happy to provide it. Why? Because by some estimates, dealerships make a quarter of their profit from each car sale through financing and insurance products like extended warranties, alarm systems, and gap insurance.
Dealerships make a bulk of this money by securing financing from lenders at a certain interest rate and then selling it to customers at a higher rate. Then they simply pocket the difference. Currently, salespeople are not required to reveal the rate hike to customers. So, while they may say you’re getting a good deal, chances are it’s the dealer who’s really coming out on top.
Getting financing through the dealership may seem like your only option if you go on the weekend when credit unions and banks are closed. But you’re much better off securing auto financing ahead of time through a trusted financial institution like the Credit Union of Texas. We offer competitive rates and will do whatever we can to help you achieve your car buying dreams.
What does this mean for car buyers?
Knowing how car dealers make their money can help car buyers in a number of ways. First, it’s important to understand that haggling over the price of a new car will only get you so far. Chances are, their margins are already fairly low. If you can see the invoice price that the dealership paid, you can determine what their profit margin would be and figure out a fair price. If you want to upgrade your car with select add-ons, you can do that. But just know that you’re likely paying a premium to do so.
Also, it’s almost never a good idea to get financing from the dealership. You’re much more likely to find a better rate through your local credit union or bank. If you have financing in place when you visit the dealership, don’t tell the salesperson right away. If they know they won’t be able to make any money from financing the deal, they may be less willing to negotiate on price.
Not every dealership is the same. Some salespeople are salaried and don’t work on commission. Some service centers are more honest about costs than others. But in general, arming yourself with as much information as possible is the best way to ensure you get a good deal when you buy a car. By understanding how dealers make their money, you can drive off the lot feeling confident you made the right decision.
Ready to buy a car of your own? The Credit Union of Texas can help with all your auto financing needs, and our financial experts can help you figure out the perfect budget for your next vehicle purchase. Before you visit the dealership, contact us or stop into one of our many convenient locations.