Finance and Insurance - The Profit Center
I would like to make myself clear on a few items of interest before I get too deep into the sales processes at any dealership, including: automobile, recreational vehicles, boats, motorcycle, and even furniture or other big ticket items. A business has to turn a fair profit in order to stay in business. I believe that they should make this profit and use it to pay better quality employees a premium wage in order to serve you better. The financial strengths or weaknesses of any business can definitely have a dramatic effect on your customer service and satisfaction. I do not, in any shape or form, wish to hurt a dealerships profitability, as it is essential for his survival. I merely want to advise people how to negotiate a little better in order to make the profit center more balanced.
Let's get right down to this! Every dealership has a finance and insurance department. This department is a huge profit center in any dealership. In some cases, it earns more money than the sale of the automobile itself. Profits are made from many things that most buyers do not understand.
You as a consumer should understand the "flow" of the sales process to understand the profit centers that are ahead of you. Most negotiating from the consumer seems to stop after the original price is negotiated and agreed upon. Let's examine just a small portion of what leads up to that point.
The first thing that every consumer should understand is that when you go to a dealership several things come into play. One of the most important things that I could point out to you is that you are dealing with a business that has been trained to get the most amount of money from you as they can. They are trained and they practice these tactics everyday, day after day, week after week, month after month, and year after year. Let me point out a couple of important facts that I have said in this paragraph. First, you'll notice that I said a dealership and not a salesman and secondly, I emphasized times of day after day, week after week, etc. etc. This was done to let you know that the salesman is working very closely with the sales managers in order to make as much money as he can. Your interests are really not their objective in most cases.
One tactic that is used heavily in the business is that the salesman says he is new to the business. This may be true or not, however; keep in mind that he does not work alone. He is working with store management, who gives him advice on what to say and when to say it. These guys or gals are very well trained on how to overcome every objection that you may have to buying from them. They have been trained in the psychology of the buyer and how to tell what your "hot buttons" are. They listen to things in your conversation that you may say to one another as well as to the salesman. They are trained to tell their desk managers everything that you say and then the desk manager is trained to tell the salesman exactly what and how to answer you. A seasoned salesman does not need as much advice from his desk and may negotiate a little more with you directly without going back and forth.
The process of negotiation begins the moment that you walk into the front door or step foot out of your car and begin to look at vehicles. Different stores display inventory in different ways. This is done for crowd control or more commonly known as "up control". Control is the first step in negotiating with a customer. Ever who asks the questions controls the situation. Let me give you an example: A salesman walks up to you and says "Welcome to ABC motors, my name is Joe, and what is yours?" The salesman has just asked the first question- you answer "My name is George." He then asks you what you are looking for today, or; the famous "Can I help You?" As you can see, step after step, question after question, he leads you down a path that he is trained to do.
Many times a well trained salesperson will not answer your questions directly. In some cases, they only respond to questions with other questions in order to avert the loss of control. An example of this could be something like you asking the salesman if he has this same car with an automatic rather than a stick shift. Two responses could come back to you. One would be yes or no, the other could very well be something along the lines of: 'don't you know how to drive a stick shift?" In the second response the salesman gained more information from you in order to close you. Closing means to overcome every objection and give your customer no way out other than where do I sign. The art of selling truly is a science of well scripted roll playing and rehearsal.
We have established that the negotiating process begins with a series of questions. These questions serve as two main elements of the sales process. First and foremost is to establish rapport and control. The more information that you are willing to share with you salesman in the first few minutes gives him a greater control of the sales process. He has gathered mental notes on our ability to purchase such as whether you have a trade in or not, if you have a down payment, how much can you afford, are you the only decision maker (is there a spouse?), how is your credit, or do you have a payoff on your trade in? These are one of many pieces of information that they collect immediately. Secondly, this information is used to begin a conversation with store management about who the salesman is with, what are they looking for, and what is their ability to purchase. Generally, a sales manager then directs the sales process from his seat in the "tower". A seat that generally overlooks the sales floor or the sales lot. He is kind of like a conductor of an orchestra, seeing all, and hearing all.
I cannot describe the entire sales process with you as this varies from dealer to dealer, however; the basic principals of the sale do not vary too much. Most dealerships get started after a demo or test drive. Usually a salesman gets a sheet of paper out that is called a four square. The four square is normally used to find the customer's "hot points". The four corners of the sheet have the following items addressed, not necessarily in this order. Number one is sales price, number two is trade value, number three is down payment, and number four is monthly payments. The idea here is to reduce three out of the four items and focus on YOUR hot button. Every person settles in on something different. The idea for the salesman is to get you to focus and commit to one or two of the hot buttons without even addressing the other two or three items. When you do settle in on one of the items on the four square, the process of closing you becomes much easier.
One thing to keep in mind is that all four items are usually negotiable and are usually submitted to you the first time in a manner as to maximize the profit that the dealer earns on the deal. Usually the MSRP is listed unless there is a sales price that is advertised (in may cases the vehicle is advertised, but; you are not aware). The trade value is usually first submitted to you as wholesale value. Most dealers request 25-33% down payment. Most monthly payments are inflated using maximum rate. What this all boils down to is that the price is usually always negotiable, the trade in is definitely negotiable, the down payment may be what you choose, and the monthly payment and interest rates are most certainly negotiable. If you do your homework prior to a dealership visit you can go into the negotiation process better armed. You still need to keep two things in mind through this process. The first item is that you are dealing with a sales TEAM that is usually highly skilled and money motivated. The more you pay the more they earn. The second item to remember is that you may have done your homework and think that you are getting a great deal and the dealer is still making a lot of money. The latter part of this statement goes back to the fact that it is essential for a dealer to make a "fair" profit in order to serve you better.
Once your negotiations are somewhat settled, you are then taken to the business or finance department to finalize your paperwork. Keep in mind that this too is another negotiating process. In fact, the finance manager is usually one of the top trained sales associates that definitely knows all the ins and outs of maximizing the dealerships profit. It is in the finance department that many dealers actually earn more than they earned by selling the car, boat, RV, or other large ticket item to you. We will break these profit centers down for you and enlighten you as to how the process usually works. Remember that finance people are more often than not a superior skilled negotiator that is still representing the dealership. It may seem that he or she has your best interests at heart, but; they are still profit centered.
The real problem with finance departments are that the average consumer has just put his or her guard down. They have just negotiated hard for what is assumed to be a good deal. They have taken this deal at full faced value and assume that all negotiations are done. The average consumer doesn't even have an understanding of finances or how the finance department functions. The average consumer nearly "lays down" for anything that the finance manager says. The interest rate is one of the largest profit centers in the finance department. For example, the dealership buys the interest rate from the bank the same way that he buys the car from the manufacturer. He may only have to pay 6% to the bank for a $25,000 loan. He can then charge you 8% for that same $25,000. The dealer is paid on the difference. If this is a five year loan that amount could very well be $2,000. So the dealer makes an additional $2,000 profit on the sale when the bank funds the loan. This is called a rate spread or "reserves". In mortgages, this is disclosed at time of closing on the HUD-1 statement as Yield Spread Premium. This may also be disclosed on the Good Faith Estimate or GFE. You can see why it becomes important to understand bank rates and financing.
Many finance managers use a menu to sell aftermarket products to you. This process is very similar to the four square process that I discussed in the beginning. There are usually items like gap insurance, extended service contracts, paint and fabric guard, as well as many other after market products available from this dealer. The menu again is usually stacked up to be presented to the consumer in a way that the dealer maximizes his profitability if you take the best plan available. The presentation is usually given in a manner in which the dealer wins no matter what options are chosen. With the additional items being pitched to you at closing, your mind becomes less entrenched on the rates and terms and your focus then turns to the after market products. Each aftermarket item can very well make the dealer up to 300-400% over what he pays for these items. Gap coverage for example may cost the dealer $195.00 and is sold to the consumer for $895.00. The $700.00 is pure profit to the dealer and is very rarely negotiated down during this process. The service contract may only cost a dealer $650.00 and is being sold for $2000.00. The difference in these items are pure profit to the dealer. You see, if you only paid $995.00 for the same contract, the dealer still earns $345.00 profit from you and you still have the same coverage that you would have had if you had paid the $2000.00. The same is true for the gap coverage. You are covered the same if you paid $395.00 or $895.00 if the dealers costs are only $195.00. The only difference is the amount of profit that you paid to the dealer. Another huge profit center is paint and fabric protector. In most cases the costs to apply the product are minimal (around $125.00 on average). In many cases the dealer charges you $1200-$1800 for this paint and fabric guard.
As you can see, these products sold in the finance department are huge profit centers and are negotiable. I also have to recommend the value of most all products sold in a finance department. It is in your best interest to get the best coverage possible at the best price possible. Always remember this: The dealer has to make a fair profit to stay in business. It just doesn't have to be all out of your pocket.
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Financing 101 For Home Buyers
There are 4 major ways to finance your home buying:
Take a mortgage - the most common way.
Pay cash - no need to explain that.
use government loans - such as FHA and VA loans. Requires meeting specific standards.
use hard money lenders - usually used by investors for a short period of time since the interest is significantly higher.
This article will try and help you, the home buyer, have better understanding of the mortgage taking process.
The process starts with doing some homework; Write down the following numbers:
Annual household income
Total debt - credit cards, student loans etc
Current housing expenses - what's the rent / mortgage payments you currently have.
Average monthly expenses on credit cards
Monthly payments on financing - such as student loans and auto financing
Once you have these numbers written down, you are ready to go see a loan officer.
It doesn't matter which loan officer you go to start your financial investigation, the only thing that is important is that he won't be the last you see! The best advice anyone can give you about taking a mortgage is shop around! This is one of the biggest financial transactions you will ever do and every little change in the interest rate means a lot (!) of money over 30 years.
When you meet the loan officer for the first time you will hear a lot of terms you never heard before and it's important you understand every detail and term of the loan in order to be able to compare between the different loans offered to you by the different lenders.
There are many types of loans but the most common are:
Fixed interest
ARM - adjustable rate mortgage
Increasing/decreasing mortgages
Balloon / interest only mortgage
Government loans
The Fixed Interest loans are the most commonly chosen mortgage and it means your interest is locked at the beginning of the loan term and stays the same for the duration of the loan. The most common fixed loan duration is 30 years but there are 20, 15 and 10 years options as well.
What does it mean that the interest rate is fixed? It means you have the same monthly payment for the duration of the loan (no increase and no decrease) i.e. if your monthly payment is $1000 today it will be the same 10, 15, 20 years from now.
The ARM loans means your loan's interest rate will change every few years to the market standard at that time. Meaning if your interest rate at the beginning of the loan would be 6% and five years down the road you have a re-calculation point and the market rates are 4% then your monthly payment will decrease; BUT if the market rates are 8% then your monthly payment will increase. ARM loans have re-calculation points every few years for the entire duration of the loan. The re-calculation points are determined at the beginning of the loan (pre-set to 3/5/7 years or any other terms the lenders offer).
Increasing/decreasing loans - a variation of the ARM mortgage where you start paying only the interest for the first few years and adding the principle component after a few years (this is increasing payments) or you start by paying more into the principle in the first few years then you reduce the amount paid towards the principle (decreasing your payments)
The balloon / interest only loans will have you pay just the interest part of the payment for the duration of the loan and you will have to pay the entire principal amount at the end of the loan term. I.e. if you take $100,000 for 30 years on a balloon loan you pay interest payments for 30 years and at the end of the 30 years, you still owe the bank $100,000. This type of loan is usually used by investors that need to keep the holding (carrying) costs low while they fix up a property and prepare it for resale.
Government loans - there are all kinds of government loans, we will not cover them in this article.
Mortgage Type: Fixed Rate
Pro's:
Better control on your monthly expenses
payment will be deflated over the years (what you could buy for $100 20 years ago is not what you can buy with it today)
you start reducing your principle amount from the first payment
Con's
Usually the rates will be a bit higher then you can find in the other options but for the long run the amounts even out
Mortgage Type: ARM
Pro's:
Helps reduce the payments in the first few years
Should be considered when the interest rates are high and are expected to drop in a few years
Con's
It's a gamble, a few years down the road when it's time to re-evaluate the loan's rate, the market rates can be much higher
Mortgage Type: Increasing/Decreasing
Pro's:
Can help reduce payments in the first few years while your career picks up (increasing)
Allows you to put more money towards the principle while you can afford the extra payments (decreasing)/li>
Con's
Same risks as the ARM
Mortgage Type: Balloon
Pro's:
Lower monthly payments = lower holding costs
Con's
After the term of the loan you still owe the original amount you borrowed.
So you decided on the type of loan that fits your needs. Good. Now you need to discuss the terms with your lender. Remember, SHOP AROUND and compare prices and terms. Don't hesitate to show the lenders the other offers you got and ask them to beat them.
The loan terms
Aside from the loan duration and total amount borrowed the loan has some more terms to it and they all must be factored into consideration when deciding.
Rate - The most important factor is the loan's rate. Your loan officer will give you two numbers for the rate. The loan's rate percentage and the APR percentage. The APR is the annual percentage rate of the loan. The "real" rate. It is the loan's rate PLUS all kind of charges that the bank applies on the loan divided over the life time of the loan. Naturally, the APR is higher the regular rate, so when you compare loan rates compare them by the APR rates!
Fees - These can be a real deal breaker. The banks have all kind of fees:
Application Fee - you pay money so the bank will tell you IF they are willing to give you a loan. This fee is waived today by most major banks.
Closing Fees - the bank has expenses when they issue a loan. The bank is charging you all kind of closing fees. You will hear terms like origination fee, lender's fee, document preparation fee, underwriting fee, commitment fee and the list is lonnnngggg..... Some banks will tell you they will "waive" these fees for you, don't fall for it. This is exactly what they use the APR for. You will pay for it but in a different way and spread over the duration of the loan. This kind of "offer" is very helpful when you don't want to spend a lot of cash when you take the loan. I can tell you that even if a bank is not offering "no closing fees" official, most of them will agree to "waive" it and change the APR rate.
Points - Most banks are willing to sell you a better rate. They use a term called "points". each point will reduce the APR (and thus decreasing the monthly payment) and it will cost you money. The "price" of a point is calculated of the amount of the loan. Ask your loan officer to show you the different points options and you can make a decision if this fits your needs (I.e. if 1 point reduced your monthly payment by $10 and it costs $1000 then it'll take you 100 months to return your investment on buying that point. But if it costs just $200 then 20 months will return your investment) everyone has a different number of months to determine if buying the points is worth your money. A rule of thumb would be if you can return your investment in 4-5 years then it's worth it.
Bare in mind that the money you pay for the points is gone no matter when you close the loan or refinance.
Exit Terms - Every loan has exit terms. It's important to know them and to be OK with them. The best would be no fees for early termination.
Extra Payments - You should ask your loan officer if you can make extra payment into the mortgage and how often. Most of the loans today allow extra payments at any time.
Down Payment - These days the lenders won't let you have 100% financing they require you to put in a down payment towards buying the property. The minimum accepted is usually 5%
PMI / Mortgage Insurance - All lenders will require a PMI on loans that are more then 80% of the property value. This increases the monthly payment. Same as with the closing fees some lenders will offer "No PMI" you will see it in the APR. The basic rule of the PMI is that it's needed when the amount of the loan is greater then 80% of the property value. This also means that after a few years of payments your loan balance goes below the 80% mark and you stop paying the PMI component of the payment.
So you know your loan's terms and you shopped around and you have made a decision to go with lender X. your next step is locking the rate. For that you will have to contact your loan officer and sign a form locking the rate for 30 days (some lenders will lock it for longer) and pay a locking fee. This guarantees that while the bank is going through the underwriting and the preparation of the documents you won't be affected by the market fluctuations. Most lenders have a cause saying that if the rate goes DOWN with in that period in over 0.25% or 0.5% (varies between the lenders), they will adjust the rate down to reflect the change. It's very important to understand from your loan officer that they do that and what is that threshold. It's also very important to follow the rates after you lock and make sure that if there is a need for adjustment, it does occur. Mortgage rates change daily so make sure you stay on top of it.
From this point the lender will guide you through it's own process, ask you for documents and so on. ALL LENDERS will require a "home owners" insurance and all of them will offer you one. Don't take it! It's almost always more expensive then if you shop around and buy it for yourself.