Just like a store that sells products and keeps them on the shelves with an inventory, car dealers are no different.  Basically, all of the cars you see on their lot is their inventory.  And just like other retailers they buy the cars from Honda, GM, Toyota or whomever and then sell them at a profit.   So, how can a dealer possibly make a profit on a car they just sold for “factory invoice” meaning the price the auto manufacturer charged the dealer for the car?  Well, here’s how.  Dealer incentives.  When General Motors notices one of their latest models is not selling very well, they give the dealers “incentives” (i.e., cash rebates to the dealer directly) to start unloading these vehicles.  GM may charge a dealer $19,000 for a new Chevy Malibu.  Let’s say in a slow economy that dealer is having a hard time selling those Malibus for much higher than $19,000.  What does GM do?  They may send the dealer $3,000 per Malibu sold just to jump start their numbers of that model.  Dealer paid $19,000, sold it for $0 profit but received $3k back from GM and the consumer thinks he got the car at “dealer invoice” price.  Everyone here is a winner, right?  Wrong.  GM, as usual, is the financial loser here.  By giving back that $3,000 to the dealer they may have actually lost money on that car.  So now you can see why General Motors has been in such a financial quagmire for so long.  

In addition to the car company incenting the dealer to sell those cars, the dealer and/or the car company often give cash back, 0% financing or other perks to the consumer directly.  Why is this?  It’s because they will always have a continual need to sell model-year cars.  Do you really think GM gives cash incentives to dealers to sell used cars?  Of course not!  The car companies are always under tremendous pressure to hit certain sales figures per year.  Why do you think the Ford Taurus and Honda Accord battled so long for the title of “best selling car in America”?  That whole thing was a sham as well because Ford included fleet sales to car rental companies in their sales figures and Honda doesn’t even sell many to rental companies.  

So the next time you or a friend think you just got a steal by getting a car at dealer invoice, think again.

1) Financing: Blame Billy Durant

Billy Durant was the founder of General Motors. When the company began to really grow in the early 1900s he proposed the concept of “installment loans” to finance the purchase of cars for which folks did not have the cash. Mr. Durant created the General Motors Acceptance Corporation (GMAC) which at the time was the largest non-bank source for financing auto loans. His chief rival, Henry Ford, was vehemently opposed to the idea of installment loans and this one decision by Henry Ford cost him the lead in the American automobile industry. So, it could be argued that GM became the world’s largest company in the world partially by allowing customers to buy cars they could not afford! This speaks volumes about America’s obsession with driving cars they cannot afford – even back in 1919 when GMAC was formed. Financing a car is generally done by people who cannot afford to pay for the whole car at once.

2) Leasing:The Sacred Cash Cow of Auto Companies

Many struggling and even profitable auto companies make most or all of their profits from their financing division. Exactly like the story of Sears at one point being a finance company with some goods out front, auto companies are often in the same boat. Below are just brief snippets of recent news stories about the auto industrie’s profits:

“Ford Posts Profit as Finance Unit Offsets Auto Losses”

“DaimlerChrysler said Thursday that fourth-quarter profit rose 84 percent on gains in vehicle financing and sales of Chrysler cars…has counted on earnings growth at Chrysler, commercial-vehicle and financing divisions to more than offset declining profit at Mercedes.”

“Ford Profits Surges On Strength of Financing”

The above headlines demonstrate that these car companies are basically making products that lose money year after year, yet consumers that finance or lease through these company’s in-house leasing divisions contribute to the only profits of the companies. So, it could be argued that certain car companies only make profits from customers who lease. They do not even make money on their chief product: cars! Leasing is not only a rip-off for consumers, but it artificially inflates the profits of companies that otherwise would be going out of business if they exclusively stuck to their core industries.

Another reason that leasing is so popular is that it lets you drive a car you cannot afford. Otherwise, buyers would be stuck getting cars within their means and within their budgets which would likely be older, cheaper and less of a status symbol.

3) Paying Cash: The Epitome of Weird

How many people do you know who pay cash for their cars? I can probably count that number on one hand. Paying cash for a car is just plain weird. But borrowing or financing the car is normal, right? Who wants to be weird? Well, those “weird folks” have learned the truth about car payments. The truth about car payments is this: car dealers, on average, make $1200 on leased cars, $700 on financed cars and $72 on cash-purchased cars. Yes, you read that correctly. $72 profit on customers who pay cash for their cars. So, if you are a car salesman which financial product are you going to push?

If paying cash seems out reach for you, then ask yourself this question: have you ever missed a car payment? Has it ever been a stretch to make the car payment each month? If the answer is no, then why not discipline yourself to make a “virtual car payment” each month (say, $350 per month) even when it does not go to a real car payment. Take that cash of $350 per month, save it for 3 years and you’re at $12,600 which can buy a decent used car. You don’t spend a time on financing interest, you can negotiate better with the dealer and you reach a financial goal you set for yourself. This is something on which a price cannot be put.

Car leases. Noted financial expert Dave Ramsey mentions an astounding statistic in his book the Financial Peace Revisited. He claims that on average a car dealer makes $1200 profit from customers who lease the car, $700 profit from those who finance the car and $72 from those who pay cash for the car. The single biggest reason that leasing is so popular is that it lets you drive a car you cannot afford. I currently drive a car that is ten years old and my wife drives one that is eight years old. People who need a new car every three years rationalize it by telling themselves that older cars are unsafe. This is a load of malarkey. Both of my older cars have anti-lock brakes, security systems and more. Ideally you should pay cash or use a low-interest home equity line of credit when you purchase a car. If financing is your only option try to pay it off in two or three years.

Reverse mortgages. I truly feel sorry for senior citizens that are duped into signing on to a reverse mortage. What’s worse is that apparently the AARP endorses these products as evidenced by the site rmaarp. A quick synopis of the estimate I did for my parent’s home yields a return that royally stinks. You are basically signing over 20% – 40% of the value of the house to your lender. To add insult to injury the federal government insure some of these HECMs (home equity conversion mortgage) which essentially turns the equity into your house into a pseudo-annuity that they’d lead you to think you will get for life. However, these reverse mortgages have minimum age requirements of usually 62 years old or higher. It doesn’t take a genius to realize the actuarial tables have your life expectency nailed down as a certain level of risk based on when you’ll die. I understand why seniors opt for this product. They do it to generate cash if they did not effectively plan for retirement. That does not make it a good idea.

Warranties. As detailed in Secrets of the Big Box Stores retailers, just like reverse mortgage lenders, are playing the statistics to maximize profits on purchased warranties. As long as the repair costs covered by the warranties are continued to be less than the profits made by the warranties the stores will obviously keep selling them. I personally subscribe to the belief that most electronic products and automobiles are well enough made to outlast their manufacturer warranty which is nearly always included free of charge with the product. So stick with the basic free warranty and stop wasting money on the extended warranty. The majority of that warranty sale goes into the salesperson’s pocket anyway.

Payday loans. I would hope that no readers of this blog have ever used a payday loan. In essence they are used by people who a) have no savings in the bank b) who always seem to have more month left over than paycheck and c) who have no concept of a 200% – 1000% interest rate. Fortunately the U.S. Congress is stepping in to limit the interest rates to a mere 36%. The bottom line is that these payday loan lenders found a niche exploiting the poor and financially uneducated. This is one government intervention I endorse.

Buying more computer than you need. As a fifteen-year corporate I.T. veteran I can tell you that most people who buy a computer (without my assistance) spend two to three times what they need. Over 90% of computer users simply surf the Web, send emails and occassionally type up a document or letter. A decent computer that will last you three to five years can be purchased for $400 – $800. One the best sites to find a bargain on a new PC is here. No need exists to spend $1000, $1500 or God forbid $2000 on a computer today. Gamers, CAD users and graphic designers are excluded, but the rest of PC buyers should save their money for a better use.

Vacation Clubs The appeal of these clubs is that you are able to, in theory, budget a certain of amount of spending per year on your vacation while choosing among hundreds of destinations throughout the U.S. (or wherever you live).  Many times the entrance fee to “purchase” ownership in these clubs are $10k – $30k and that’s just the beginning.  Often a monthly maintenance fee is charged whether the property is used or not.  Also, enormous amounts of profits are derived from the companies by pushing upgrades or additional perks while on site at the vacation property.  Two acquaintances of mine shelled out $20,000 for the Disney Vacation Club and then spend around $400 a month just for maintenance.  This is neither a deal or prudent vacation budgeting.

Think twice before you plunge into any of the above financial pitfalls.

1. Basic Transportation

Typically a college student will think of this reason for buying a car and perhaps even exclusively this reason. Will this car get me from point A to point B? It sure beats the bus or bumming a ride off my roommate. It will get me to work and back home. It’s four wheels and a seat and that’s about it. I don’t care what it looks like, the features it has or how safe it is (within reason). It only needs to get me from here to there.

2. Reliability

On a cold winter morning when I leave the car out overnight will it still start for me reliably? Will the car be reliable for me in three years? Five years? Seven years? Japanese cars are legendary in their reliability reports according to Consumer Reports and J.D. Power and Associates but the American car companies have been making some progress over recent years. When my sick kid needs to be taken to the pediatrician will the car start when I need it most? Reliability is paramount for some people or just assumed as a basic prerequisite for others.

3. Safety

For most people Volvo comes to mind when you think car safety. If I am in an accident how protected will my family be from injury? How effective are the side air bags in this car? Does it even have side air bags? Does it have a rollover risk like SUVs? Safety is probably most often a concern of young families. Will my baby/toddler/adolescent be safe in an accident?

4. Status Symbol

Since my website talks a great deal about personal finances I could type for hours on why people buy a car as a status symbol. How cool does this car look? How cool will I look in this car? What will my friends think of this car? Does this car make me look older? Younger? Affluent? Does it make me look educated? Strong? Notice all of phrases used to describe the car as a status symbol describe how either you or the car look? I did not say one iota about how it affects the car’s safety, gas mileage, speed, reliability or performance. Buying a car as a status symbol does one thing very well: makes you spend more than you intended. I promised you my best car buying tip near the end of this article. Here it is: don’t buy a car based on how it looks.

If you can get over that one highly-overrated reason of status when buying your car (new or used) you will save a lot of money. If you are looking at high-reliability rated cars from Consumer Reports and your choice is to buy the model year version because they improved the look or a three-year-old version of the same model buy the used one! Let’s be honest; in the basic transportation, reliability and safety categories both cars are the same! Both cars get you from point A to B, they’re both reliable and they’re both safe. Is it worth your hard-earned money to spend $3000 – $4000 more on the new car? Heck, no. What exactly do you get by buying a new car versus a two to three-year-old one? In five years both cars will depreciate like a rock so why does it matter? Over five years, I’d rather go from $15,000 to nearly nothing than $19,000 to nearly nothing. A car is exactly like a bad stock invesment. After plunking down your hard-earned money it’s worth nothing in a couple years.

For help on the finances when buying that car read How To Buy A Car

To get over your “need” for high-status artifacts (like cars) read how the millionaires do it in A Year’s Salary Under the Mattress

Nothing wrong that, right?

{cover your ears while I scream at the top of my lungs}

I do not even know where to begin on this one. Let’s just say that the salesman on this deal felt like King For A Day. He probably thought to himself, “man, this guy was born yesterday.” Well, let’s break it down piece by piece. First, do NOT and I mean NOT tell them how much you want to spend. Well, duh! Isn’t the salesman going to mark up every model he shows you to meet that price maximum of yours? Second, do NOT NOT NOT mention your maximum monthly payments. Again, the salesman can easily, legally and even morally (or so he thinks) inflate the monthly payment to cover a high-priced, high-commission-for-him warranty, high interest rate on the financing and other high charges built into that monthly payment. You have no clue what the interest rate, length or terms of the loan are. I won’t even get into nickel-and-diming you to death with the warranty, rust inhibitor, dealer charges or options for the car.

To further illustrate this point here is an example.

What Should Happen

Car cost = $15,000
Terms of the loan = 5 year = 60 months
Interest rate = 6% (which can easily be beat in today’s market)

Using any of the plethora of free loan calculators on the Internet we can see that the monthly payments for this loan would be $289.99. Now, suppose you told the car salesman you could afford $290 per month. I am in no way insinuating that car salesman are dishonest, but the salesman is trying to make the best commission for himself, not you. Below is what might happen.

What Will Happen If You Trust The Salesman

He’ll sell you a $15,000 car for $17,500
Give you a 6-year loan = 72 months
Give you an interest rate of 6%
Monthly payment is $290.03

Hmmmm, let’s run through this now. He kept his promise of keeping the payments at $290 per month. You were able to afford that $15,000 car you wanted. Everybody is happy, right?

WRONG!

He raised the price of that car up $2500 but disguised the increase in the loan payments. You are now stuck with

• A ridiculously long car loan (6 years??? Like you’ll still want the car then!)
• A not-so-competitive interest rate
• And worst of all – $2500 more in the salesman’s pocket – not yours!

Dave Ramsey’s book Financial Peace Revisited taught me this about buying a car. On average, a dealer makes $1200 profit from customers who lease the car, $700 profit from those who finance the car and $72 from those who pay cash for the car. Need I stress the importance of paying cash for a car if possible or at least using a low-interest home equity loan to pay for it?

Lessons learned when buying a car:

1. Use your local bank on the corner BEFORE going to the dealer. You will often get a more competitive rate and not be tempted to “impulse buy” using the dealer’s pathetic financing.
2. Don’t ever mention your maximum price, monthly payments or any other cost. What salesman in his right mind would not charge you the maximum you can afford….or more!

Bottom Line:

Using this advice could easily lower your car payments by $50 – $100 per month

Saving On Car Costs After The Purchase

My brother Mike, my dad and I all called our car lender on the same day (one influenced the other two) and received a lower interest rate just by asking. This is a true story and was pretty funny. Mike called me and told me what he did. I did it. I then called our dad and he did it. Mike lower his payments by $23 per month. I shortened my loan length. Our dad shortened his loan length as well. Pretty amazing, huh? Do you think any bank on the planet is going to call you up and say “we’d like to start making less money from you” – HECK NO! It never ceases to amaze me what you can get just by asking.