There’s this idea out there that you should always pay cash at a car dealership if you can afford to. And the idea is pretty simple at face value. When you pay cash, you won’t have to get financing and you can avoid paying those interest charges on your monthly payments that can add up to thousands of dollars.
And, while that may be true in a few cases, in today’s car-buying world, it’s probably better most of the time to avoid paying all cash. And I’m going to explain exactly why. It really comes down to the fact that car dealerships make a large portion of their profit through financing.
So, if they know they aren’t going to get that monthly interest, they adjust the price accordingly. And, if you only take one single thing about car buying from this article, it’s that you should never say that you’re buying cash to a car dealer, even if you’re planning to.
The Business Model
Before we get into car-buying techniques and how to get the best price, I want to briefly explain how car dealerships make their money so you can get a better understanding of why paying cash is such a touchy subject around car dealerships.
Now, most people who have never worked at a car dealership or don’t have much knowledge of the industry (which is most people in the world) might think that car dealers make most of their money on the sale of the car. It makes sense.
The dealership gets the car for $18,000. They sell it to you for $20,000. The dealer takes 25% (which is typical for salespeople), so they go home with $500 and the dealership keeps the other $1,500. And that’s how they make their money. But, that actually couldn’t be further from the truth.
You see, the difference between what the dealer paid for the car and what you paid for the car (known as “front-end profit” in the industry) is only a small portion of where they make their money. In fact, front-end profit is usually only about 25% of the total gross profit of a car dealership.
The vast majority of a car dealer’s gross profits are made through servicing, selling parts, and what’s known as “F&I,” which accounted for around 53% of gross profits for car dealers in 2018 and might even be an even larger proportion today in 2022.
So, what is this mysterious F&I? Well, it stands for “finance and insurance” and these are the guys in the back office that make the real money by “helping” you finance your car and by selling you things like extended warranties, GAP insurance, service contracts, and other optional add-ons.
This is where the real money is, not in the front-end profit. And F&I products continue to become more and more important to the car dealership business model over time, especially after the pandemic. So, you’d better believe that the salesmen are focusing heavily on this when they’re looking to sell you your new car.
And the F&I department makes money in several different ways. For one, they might hook you up with an auto loan from a bank and then collect a commission. That means that, if you’re paying $100 in interest every month on your loan, the dealership might get a 25% commission of $25 every month from the bank.
The dealer might also engage in what’s known as arbitrage. Essentially, they’ll go to a bank and try to find the lowest rate. Let’s say that rate is 4%. Then, they go to you and tell you that the bank offered a rate of 6% and you take the deal. Every month when you pay your bill, the car dealership is going to pocket that 2% interest and then pass along the other 4% to the bank. Yeah, it sounds like it should be illegal, but it’s not.
They also make money by selling you extended warranties, which can be nice if you want some peace of mind and protection from costly repairs. But, in fact, a study from Consumer Reports in 2014 found that 55% of extended warranties weren’t used during the life of the policy.
And, if I were a gambler, I’d say that 5% over 50% means that the dealership is definitely winning in the long run. Then, they sell you the GAP insurance, the credit insurance, and all those other add-ons. And you’re paying a ton of money and these guys are lining their pockets.
That’s where the money’s made during a car deal: financing and insurance add-ons. So, now that you know what the salesmen are focused on, let’s get into how you can avoid paying tons of money in F&I, and how you can avoid getting screwed for paying cash at the dealer.
Don’t Tell Them You’re Paying Cash
If you do want to pay cash at the car dealership, it’s absolutely essential that you don’t tell them that early in the transaction. Do all of your price negotiations before you mention that you want to pay cash.
I’ve made this mistake before. I went into a dealership to buy a car years ago and one of the very first things that the salesman asked me was, “So how are you going to pay for this? Cash or financing?” And, being young and naive, I said “Cash!” I thought that would automatically help me get a better deal, but was I wrong.
The second that you tell the salesperson that you’re paying cash, they start thinking, Well, that 75% gross profit from F&I is out the door, so I have to start making up for that with the front-end profit. And, essentially, what that means is that your salesperson is going to be entirely unwilling to move on price.
If you can lead the salesperson to believe that they’re going to make $1,000 on you down the road from financing, then they might be willing to knock that $1,000 off the sticker price. But, if they know you’re paying cash, then they’re going to try to make that $1,000 on the front end of the sale and they’re not going to budge on price. So, don’t tell them!
In fact, if they ask you whether you’re paying cash or financing, you can tell them that you’re financing, and it may not even be a lie because you can actually pretty much pay cash… by financing!
I’ll explain that a little further in a moment, but it basically involves just financing the car and then sending a check to the bank as soon as you drive off the lot. But, before we get to that part, let’s talk about what you should look out for to get the best price in the F&I office.
In the Back Office
So, you’ve negotiated with the salesperson on the floor and you’ve told them that you’re going to be financing, which means they’re willing to wiggle on price. You said, “Hey, man, the tires look worn. Can you knock off another $300 for the price of new tires?” And you’ve finally come to a number that you’re happy with.
Then, the friendly salesman ushers you to the back office and says, “Alright, we just have some paperwork for you to fill out and we’ll get you out of here.” That salesman is going to try to make it seem like all the negotiating is done. But, in reality, this is a huge part of the negotiating process.
They’re going to sit you down at a desk and show you the purchase agreement. And it’s going to look something like this: they’re going to list the retail price (which doesn’t mean anything, it’s just a negotiating chip for the dealer).
Below is the sales price. And, if you try to make them go any lower on the sales price, they’re going to point to the retail price and say, “Well, we already came down this far from the retail price, we have no more room to come down!” They have more room. Trust me.
Below that is the sales tax, which is going to be a non-negotiable percentage of the sale price, so don’t worry about that. There’s nothing you can do there.
But, under the sales tax, there are going to be a whole bunch of fees and add-ons. These fees could be things like VIN etching, which is completely unnecessary. But, your dealer is probably going to tell you it’s non-negotiable. That’s a load of bull.
If they’re charging you $500 for VIN etching and they won’t take that fee off the contract, then tell them to take that $500 off the sale price or you’re walking out the door.
Or how about a nice dealer preparation fee, which is basically the cost of cleaning the vehicle and making it look nice? If they try to make you pay for that, you just say, “Look, cleaning the car is just part of the business expenses of running a car dealership.” If they won’t take the fee off, tell them to take it off the sales price. If they won’t do that, walk away. In truth, none of those fees are really necessary, so don’t pay them.
Under the fees, you’re going to see things like GAP insurance, extended warranties, and any accessories you may want to add on like an entertainment system or whatever. It’s really up to you whether you want to get those or not. Regardless, get that back office F&I guy to drop the price down as much as possible using all the bargaining power you have.
And, remember, if they don’t work with you, you always have the option to walk away. Don’t get so attached to a particular car that you end up way overpaying for it.
Now, that you got the price down as low as it can go, it’s time to pay for the thing. And this is where you really stick it to the dealer.
Alright, so maybe “fake financing” is not exactly the right term for this method. In fact, you are very much going to have to sign a financing agreement. But, before you do so, you need to make absolutely sure that there is no early pre-payment penalty.
You can ask your dealership about this once you’ve finalized the total price. If there’s no early pre-payment penalty and the loan terms seem pretty fair, you can go ahead and sign the dotted line.
Maybe the car dealership called the bank and they’re skimming an extra 2% interest on top of what the bank is charging you. But it doesn’t really matter. Why? Because you’re not going to pay that interest anyway.
As soon as you’ve driven off the lot in your new-to-you car, get on the phone with the lending company that you have the auto loan through. Ask them how much the principal on the loan is. It should be the total on the purchase agreement. Then, send them a check for the total amount that very same day.
Boom! You pretty much paid cash for that car! Meanwhile, the salesperson was assuming they’d make a whole bunch of money in interest off you and they gave you a big discount based on that assumption. But, in reality, you didn’t pay any interest whatsoever. Now, that’s some savvy car buying.
Of course, this method should only be used by people who were planning to buy their car in cash in the first place. Instead of telling your car salesman that you want to pay cash and having them automatically stiffen up on the price, finance the car and then just pay it off immediately.
This method can end up saving you thousands and thousands of dollars. But it’s not for everyone all the time.
When Not to Use This Method
If you’d prefer to actually finance the car and pay it off over a loan term of a year or a few years, then go ahead and do that. It could be the right move for you instead of the method I just described.
Let’s say that you feel the need to have the top-of-the-line safety features that come with a new car so you can keep your family safe, but you can’t afford to buy the car in cash. Financing the car lets you pay it off over time and extend your budget.
Similarly, you should definitely not use the method I described if it’s going to put you in a tough financial situation. For instance, let’s say that the principle on your auto loan was $25,000 and you only have $27,000 in your bank account. Then you pay off the loan all in one day and, suddenly, you don’t have enough money to pay rent. That’s not smart.
Again, this is a method that is only for people who were planning to pay cash at a dealership anyway. If you were planning to actually finance your car over a long period of time, stick with the original plan.
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