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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Real Estate Investment Strategies - Financing the Deal
What do you mean finance the deal - isn't this about acquiring property without using your own money? Of course it is - we will get into some techniques you can use without taking your wallet out of your pocket next, but I would find this discussion somewhat incomplete if I didn't touch a little bit upon financial methods that may require some skin (yours), and naturally, a pretty good credit score.
Conventional: When I got started, I didn't have a couple hundred G's sitting in my bank account ready to plop down on my first rehab opportunity - perhaps you're in the same boat. But I did have good credit. If this is the case for you, consider doing what I did and visiting with your favorite mortgage broker (should also be on your professional team, right?). Get yourself a standing pre-approval - this will need to be updated from time to time but this is a nice tool to have in your arsenal.
Why? Because it is necessary when you go MLS shopping - you know, scouring for great deals on your local multiple listing service with your agent - the same agent you chose to become part of your professional team. Let's not get confused here: remember, MLS shopping is only one of the ways you are employing to find sellers, certainly not your only way. Don't forget to continue your targeted mailing, signs, flyers, door knocking/leave behinds, classified ads, internet strategy...
Are there deals on the MLS? Yes and no, I certainly couldn't speak for where you live, but I do go shopping in my area for REO's, short sales, and fixer-uppers on the MLS and I do indeed put offers on them. Not all of them are available for the price you need, but then again, some are. You will find out who is ready to play ball (the motivated seller) and who prefers to stay listed (the unmotivated seller) right away based on the seller's counter offer.
Here's why you need to have that pre-approval we discussed above - it needs to be submitted now with your offer, without that pre-approval you're just wasting everyone's time. By the way, if you do have that $200k in your bank account, skip the pre-approval and whip out your proof of funds.
Not to belabor the point, but if you are lucky enough to have an abundance of cash, give me a call (just kidding, kind of) use it - a cash offer that is free and clear of any mortgage contingencies will always rise to the top of the pile if you find yourself bidding against other investors.
So I have a standing pre-approval for submitting offers, and I will use conventional financing if I find something that makes sense to buy and hold. If you have credit issues that will prevent a lender from sending over a pre-approval letter, don't sweat it, let's look at some other alternatives that may be available for you.
Credit Lines: these can be secured or unsecured. I have a home equity line that I can tap into and I also have 2 unsecured lines I have access to (through another business). If you are a homeowner with a good amount of equity, you can speak with your lender (also a professional team member), about acquiring a HELOC. If you have another business that is credit worthy and in good standing you may want to also consider an unsecured line of credit. This type of financing is good for down payments, rehab costs, and (depending on your market prices and the amount of your lines) they can also be used to acquire a property outright with cash.
Hard Money: this type of lender will have some pretty steep terms, but if you have purchased the property correctly, the sale of the repaired property will take care of the points and elevated interest rate necessary to squeeze into this type of loan. The good news here is that the lender will analyze the numbers associated with property you are trying to purchase rather than your FICO score. So if you are having an issue with getting into a conventional loan, this may be a nice alternative.
The less than good news is that these lenders are looking for some of your personal participation (see credit lines above). In my area, I have found that the hard money lenders are scrutinizing the potential deal much more so than in the past. Prepare yourself to be grilled over your comparables, repair estimates, and ARV (After Repair Value). Like a lot of the conventional lenders we have been hearing about over the past 2 years, hard money lenders have eaten their share of deals gone bad and have had to foreclose on a large number of properties. As a result, the hard money lenders have also tightened their lending policies just like the conventional lenders.
Speaking of ARV get to know it, and the necessary metrics involved in determining whether you have a deal or a dud. The standard formula form the not too distant past has been: ARV*70% - Repair Costs = MAO (maximum allowable offer). But in today's declining real estate market, you will need to be a bit more conservative, especially if you are going to deal with a hard money lender - Look for picking up property for 50-60% of ARV, the lower the better...
Private Money: of course if you are fortunate enough to find a private lender or two - you know, one who will finance your deal for a fair return on their risk - then by all means, pass right to go! Finding a private lender(s) will certainly save you time navigating through today's rocky credit markets and allow you to spend your time finding deals! This is a point that should not be overlooked - let everyone know about what you do, the value you bring to your community - have you seen the returns on Wall Street lately? This is a great time to let the world know about alternative investment opportunities - network, network, network....
Securing financing will be a good first step for the beginning investor and it will also instill some confidence behind those offers you will be submitting. Yes indeed these different methods will require some personal finance/credit analysis by your choice of lender - if you need no money/no credit alternatives, stay tuned for our next discussion on creative financing: controlling property with options.
Kevin Sullivan is an active real estate investor and owner of Maplegate Realty.