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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Options, Lease-Options, And Seller Financing Agreements - Part 3
Technique #3, Sales Agreements:
When I first started out in the Real Estate Investment game I bought a lot of properties on Sales Agreements - called Land Contracts in some states. A Sales Agreement is a contract of sale between the buyer and the seller wherein the buyer agrees to pay a certain price for the property, and the seller provides financing for a portion of that price, agreeing to accept monthly payments amortized over a certain period of time and at a certain rate of interest. In my case, when I drew up the agreements the seller was providing financing for 100% of the purchase price, and often no interest was being charged. There were no payments for the first 6 months, and from the seventh month on payments were amortized for 30 years, with a balloon payment 12 to 18 months into the contract. During the first 6 months I either planned on selling the property, and what I owed the seller would be deducted from the proceeds of sale with me keeping the spread; or, if I was keeping the property as an income producer, I would renovate it and put a tenant inside to provide income. Then, from the seventh month on, I would season the contract by building up a history of timely payments to the seller and refinance the property with a traditional lender 12 to 18 months into the contract.
Still, the times when I planned on keeping the property for the long term were rare. Most of the time I was buying it for quick resale, and I had to incorporate sales agreements into my creative financing arsenal because I didn't have enough of a bankroll to buy multiple properties with cash and renovate them at the same time. Nor was it cost effective to use conventional financing for the purchases due to the constraints of low loan to value ratios - the percentage of the purchase price banks were willing to lend - and the prepayment penalties the lenders assessed when the loans were paid off in the short term. Moreover, since the majority of properties I was buying were in need of renovations, I needed a way to buy the properties with 100% financing so I could use my available capital to renovate them.
You would think that sellers going into deals like these would be suspicious of the contracts I provided and would insist on having their attorneys draw up contracts specifically designed to protect their interests. But I never had a single instance where a seller required that their attorney prepare the contract. On a few instances, they had their attorneys review my contracts. But in each case, if the attorney suggested an amendment to the contract, it was trivial. I used a simple one page, single spaced sales agreement protecting the seller in the event of default. However, it also protected my interests as the buyer, with one very important clause that I was never willing to remove: the right for me to assign the contract and substitute the assignee in my place as the party responsible for living up to the terms and conditions of the agreement.
This was critical because in some instances I wholesaled the properties right away to other investors in return for hefty assignment fees. I needed to be protected in the event that the assignees defaulted on the agreements. With traditional assignment clauses, the assignors are still on the hook in the event that the assignees default. I inserted language into my assignment clauses substituting the assignees in my place in the event of default, a crucial difference.
Now the inevitable question arises: Why would a seller agree to all of this? The answer is the same as when this question was posed in the two earlier articles I wrote in this series pertaining to Options and Lease-options: In most instances, the properties were in poor condition and the sellers were unable to sell them either through Realtors® or by themselves. I was inserting myself into the equation not as a carpet bagger looking to take advantage of their misfortunes, but as the answer to their problems. I never made any bones about the fact that I intended to make money on the deals, but they didn't care so long as I solved their problems. To that end, they were willing to do what I wanted them to do so long as they perceived it as furthering their goals.
In instances where I didn't wholesale the properties right away, I renovated them in order to sell them later at a retail price. At the beginning I paid for the renovations myself. As time progressed and my knowledge of real estate investing became more sophisticated, I recruited Hard Money Lenders to fund the renovations. In the instances where Hard Money Lenders were involved, the amounts the sellers owed on their first mortgages were relatively low. The sellers agreed to allow the Hard Money Lenders to put second mortgages on the properties to cover the amounts borrowed for renovations, so that the cumulative amounts of both the first and second mortgages were a low enough percentage of the properties' value for the lenders to feel comfortable in the event of loan default. I then went on to renovate the properties and resell them, at which point both the sellers and lenders got paid what they were owed, and I kept the rest.
I've used Sales Agreements on nice properties as well (it just happens that I've used them on a lot more ugly ones). In fact, I bought a house on a Sales Agreement in 1999 for $190,000 that I only had to put $10 down on. I made payments to the seller for a year, and then refinanced 100% of the outstanding balance, with the seller paying all of the closing costs. I lived in the house for another 7 years, put maybe $10,000 into upgrades, and sold it in December of 2007 for my asking price of $291,000. You do the math. That's a decent spread in anyone's book.
When structured right, sales agreements are a great way to buy properties with little or no money down. If you structure them the way I've described, you can even defer the payments long enough to sell the properties and incorporate Hard Money into the deals to make them truly $0 out of pocket. I began writing this series of articles in answer to those people with little money, poor credit, or both, who were constantly asking me how to get into Real Estate Investing. Now you know: Options, Lease-options and Sales Agreements. Now go out and put some deals together! And if you need some one-on-one coaching along the way to insure your success, visit me at my Web site and click the "Success Coaching" link on the navigation bar. Good luck!
Frank Lawson is the author of [http://www.profitsafely.com], the Online Resource for Real Estate Investors and Hard Money Lenders. With today's record numbers of real estate foreclosures, this is the greatest market for investment real estate in the past 15 years. Real Estate Investors need capital in order to take advantage of these incredible opportunities. Hard Money Lenders need borrowers. Both, however, must proceed cautiously. Frank's mission is to empower them all with knowledge in order that they might Profit Safely...