The Shocking Truth About How Car Dealers Make Money: Off of Servicing Your Vehicle, Arranging Your Financing, and Selling You “Extended Warranties” and other F&I Products
In 2015, financial results for the six publicly traded, new-car dealer groups in the United States showed that dealerships are in the business of selling cars so they can service them and finance them.
Compared to the new-car department, gross profit margins for dealerships are much higher for service and parts, where they may have a captive market; also for arranging financing; and for selling extras like extended-service contracts, often called “extended warranties.” (Notably, they do NOT extend the manufacturer warranty, but instead basically are repair insurance from third parties.)
For extended-service contracts, the markup can be as high as 100 percent. In California, it is not uncommon to see these products purchased by dealers for a few hundred dollars, but sold to consumer for between $2,000 and $3,500. Huge profits indeed!
Dealerships also make a profit on loans and leases negotiated at the dealership. In effect, the dealer gets a cut of the interest rate profit made by the lender. Although the amount the dealership may mark such loans up is capped in California, the profits are still large. In California, dealers may not receive more than 2.5% from lenders for arranging financing if your car loan is up to 60 months long, or 2% if it is longer.
Dealers make their money here through what is known as a finance reserve. This is an extra percentage added to your interest rate – usually 1 to 3% nationally.
Here is an example, a dealer may be able to get you financed at a 5% interest rate through one of their lending partners. This is called the “buy rate.” This is the rate at which the bank is willing to loan you the money.
The dealer will then keep this figure hidden from you. They only show the “sell rate”, the interest rate that includes their commission. In this case, it may be 7%.
This 2% difference is where the dealer makes their money when they arrange the financing for you.
It may not seem like much, but an additional 2% interest can really add up over the life of a loan. For example, if you were borrowing $25,000 over a 60 month term, a 2% finance commission would come out to $1,291. That is the profit the dealer would make on a 2% finance reserve.
Dealerships also sell “F&I” products like GAP, which is short for Guaranteed Asset Protection. If your car is stolen or totaled in an accident, GAP covers the difference between the remaining balance on your loan and the car’s actual value, which is often a lot less than the remaining balance. Commonly sold by dealers to consumers in California for $895, dealers usually only pay between $150 to $350, insuring them a huge profit.