Why is the car dealer insisting on a loan instead of cash?

Question

I saw a question that said "He (dealer) knocked down the price quite a bit" but my experience is different. The dealership says that they have a US$1500 incentive if I take a loan from their financing company.

That looks like a great offer on a $30k car, but I simply don't want a loan as the APR is 5% and the money in the bank is earning less than 1%. The dealer says that I can pay off the loan after a month, but for the promotion, the loan is a must have. I also saw a question, but it seems like the car dealer makes more money from a loan than from a cash sale. The dealer did not budge so also I did not budge, but I wonder.

Answer 1

It is a zero-sum game between you, the dealer, and the bank, so the key question is: if you take this loan and pay it after a month, who will be the loser in the end, as compared to the scenario in which you pay in cash and do not get the reduction of 1500$?

I see three possibilities:

(i) The loser will be you because of a trap in the fine print of the loan conditions. For example, there may be a prepayment penalty or some fees. The loan conditions may be worded in a very tricky way and refer to some external documents such as general policies of the bank or some fee schedule. The bank may be hoping that you won't be scrupulous enough to check everything.

(ii) The loser will be the dealer, and his story about promotion is a cover-up of his preparedness to reduce the price and his own profit in order to make a deal.

(iii) The loser will be the bank, which may be hoping that you will elect not to pay the loan after a month and will use the money to buy something else.

I cannot exclude any of these possibilities.

What you can do is to exclude possibility (i) by carefully reading the loan conditions. If you exclude that possibility, then it doesn't matter for you whether it is possibility (ii) or possibility (iii) that is going to occur.

Please note that I have never lived in the US. I typed my answer simply because I wanted to say that it is a zero-sum game. I just thought that understanding this fact might help look at the situation from a somewhat different angle as compared to other answers.

Answer 2

The dealer makes money on the loan. The amount depends on the relationship between the dealer and the finance company. Basically, you getting a loan increases the dealer's commission and so you can indeed negotiate a lower price. The dealer may also have incentives to close x number of loans per month, so he could have additional motivations.

He's probably mostly telling the truth. Look at the fine print carefully and if there is indeed no prepayment penalty, you could actually save money on the deal by getting the loan, paying just one month of interest, and then pay it off.

I've done this myself: financed a car and paid off the loan immediately (within a couple days) in order to get the best deal possible. You can also sometimes put the down payment on a credit card and get some air miles/points, too.

Answer 3

It's important to note that there can be lots of variations in a given, specific scenario. Dealers may behave differently on different deals over time, and there may be specific reasons behind that which we will never know.

That said, speaking generally, the biggest reason why dealers prefer finance for some cases is when they are getting a kickback from the lender. Often, a dealer will push the in-house lender (i.e. Ford Motor Credit Company at a Ford dealership). Or, they may have a relationship with a different lender. These relationships are often built on the dealer receiving an incentive for every loan they sell. Sometimes, a portion of the incentive is meant to be passed on to the customer. For instance, the bank may say, we will give you $1,800 for every loan you sell, if you agree to pass $1,500 of that on to the customer as a discount.

In those cases, it's pretty clear why the dealer will prefer financing, and it's also clear why they will only give you a discount if you finance.

But there may be more subtle reasons why dealers prefer one payment method over another. For instance, they may have a "favorite" bank that they work well with, who responds quickly and funds loans quickly. They may push you towards that bank out of convenience.

Also, banks generally pay origination fees to dealerships when the dealer sells the loan. These fees are usually in the range of a few hundred dollars, and they're usually a part of the contract between the bank and the dealer, and are separate from specific promotions as described above. The dealer may be willing to write off their own cost to sell the loan, in which case that fee is seen as pure profit, and the dealer has an incentive to get you to finance the vehicle.

You didn't mention credit cards, but it's typical for dealers to dislike payment by credit card, since that means that they will lose on the interchange fee, which is typically about 3% of a large transaction. That may be their entire profit margin on a new car, so they will be reluctant to take it.

Cash typically represents a completely neutral deal - there's no way to hide profit or incentives in a cash deal, since the customer is literally making a direct payment for the entire sale price. Dealers who have no bank-funded incentives may like cash more than other payment methods, but dealers who are operating with heavy incentives available from banks may prefer to push customers away from cash deals.

Before you take a loan as part of an incentive deal, with the intention of paying it off in full immediately, make sure you understand the terms and conditions of the loan. Some lenders will implement a prepayment penalty, which could erode your incentive.

Answer 4

The dealer is pushing because he gets a sales commission for placing you into that loan.

However, there's a flipside. When loans include sales commissions, they typically have early-exit charges. These exist to reimburse the lender the cost of the sales commission.

He's not mentioning that.

Otherwise, yes, salesmen and customers would conspire to rip off the lender.