Understanding Kickbacks in Car Financing: What You Need to Know
When buying a car, it's essential to understand the intricacies of car financing, especially the hidden kickback systems employed by some dealerships. This practice can significantly affect your overall financing cost, making it important to be knowledgeable and proactive. Below, we explore how kickbacks work, why dealerships benefit from these arrangements, and how to make informed decisions that are best for you.
What is a Kickback in Car Financing?
Car dealerships often benefit from kickbacks when they facilitate financing for buyers—either directly or indirectly through an affiliated bank. This is often referred to as a finance reserve in the automotive industry, where the dealer may quote a higher interest rate than the bank actually offers. For example, if a bank offers a rate of 5% but the dealer increases it to 6% or 7%, the difference is their profit, also known as the kickback.
The Buyer's Perspective
The dealer's financing rate, or sell rate, is often higher than the buy rate offered by the bank. This unauthorized markup can dramatically increase the total cost of financing. It is not uncommon for the dealer to claim a rate of 7% when the actual buy rate from the bank is 5%, resulting in a 1%-2% gain for the dealership.
The Hidden Costs of Dealer Financing
Dealerships also have other ways of profiting from financing. For instance, they might offer rates from the bank that are not your best qualification, but come with a bonus for the dealer if the loan is kept for a certain period. In some cases, a deal might be struck where the dealer gets a bonus of, for example, $2,500 for selling the loan to a bank after 90 days. Such practices further emphasize the financial benefit to the dealership from managing the loan process.
The Importance of Bank Financing
One way to avoid these kickbacks is to shop directly with a bank for financing. In fact, it’s often in your best interest to pre-qualify for a loan with multiple banks. You can get pre-approved from a primary and secondary (or even a third) bank. By doing so, you ensure that you're not overcharged and that you have a range of options to choose from. According to best practices, all inquiries made within a short period (typically 30-60 days for a mortgage or 14 days for a car loan) count as a single hard inquiry on your credit report. This approach can help you demonstrate good financial behavior, such as shopping around for the best rates.
Real-Life Example: My Experience with Financing
Back when I was looking for a Civic Del Sol, the initial payment plan offered by the dealer would have cost me an astonishing 15% interest rate on a car valued at $18,000. After factoring in the financing, the effective cost would have been $24,000. With good credit, this was absurd and far beyond a normal rate. I laughed and walked away, determined to find a better deal.
With my current car, I managed to negotiate with the dealership using a financing deal: finance for three years at a reasonable rate, and receive a $750 discount with no loan origination fee. I had to make a few regular payments before paying off the loan, but the dealership was banking on me not doing so. This was a true testament to the importance of understanding financing angles and creating leverage to negotiate the best possible deal.
Conclusion
Dealerships use various methods to profit from car financing, including kickbacks and bonuses. It's crucial to shop around for the best rates and consider financing through a bank to avoid inflated costs. By remaining informed and proactive, you can ensure that your car purchase is financially sound and beneficial.
Video Analysis: Common Mistakes in Car Financing
There are several common mistakes that buyers often make when dealing with car dealerships. A video showing such mistakes can be a valuable resource for anyone planning to finance a car. These mistakes include not understanding the interest rates quoted, not shopping around for the best financing options, and agreeing to terms without fully understanding the consequences. Watching such a video can provide insights and help you make educated decisions in the future.
Frequently Asked Questions
Q: Are kickbacks common in car financing?
A: Yes, kickbacks are common, but usually structured to appear legitimate. Dealers may quote higher interest rates to banks in exchange for incentives or bonuses.
Q: Why would a bank offer a loan to a dealer?
A: Banks may offer loans to dealers for their financial advantage, such as a bonus after the loan is sold or a long-term arrangement that provides a steady stream of business.
Q: How can I avoid being overcharged for car financing?
A: Shop around for multiple financing options, pre-qualify with multiple banks, and understand the terms of any financing arrangements you make. Compare the buy rate from the bank with the sell rate offered by the dealer.