Cars

Wheeling and Dealing

To be on sound footing when you shop for a new car, you need to know how the process works -- how dealers make their money, how much they paid for the model you want and the kinds of deals other buyers in your area are striking.

By Mark Solheim, Senior Editor, Kiplinger's Personal Finance

May 2005

Americans' love affair with cars too often turns sour in the showroom. It isn't hard to see why. You've been coached to ignore the sticker price and go in ready to haggle, but you're never sure if you're getting the best price. Or if you're getting enough for your trade-in. Or if the finance office is offering a fair deal. If you lease your new wheels, there's a whole array of arcane nooks and crannies to worry about.

Charles Lipset of Westport, Conn., wanted to lease a BMW Z4 convertible to give to his wife, Debbie, for her 40th birthday. The 39-year-old president of a mail-order business is no pushover: He made all the right moves to get a good deal. He called a nearby dealership rather than show up cold. He asked the sales manager to put his lowest price in writing via e-mail. But he couldn't shake a niggling doubt. "The dealership had stories about how good their service was and that they always made the best deal, but to me it sounded like a lot of salesmanship," he says.

So Lipset did something most of us can't -- he ran the numbers by a friend in the car business. His buddy said that instead of the $2,000 or so over invoice the dealer wanted, he should have no trouble finding one who'd take $500 over invoice for the convertible -- particularly in Connecticut in February. Still, dealer number one barely budged. So Lipset moved on to another dealer who accepted the lower offer, trimming $10 off each of the 36 monthly payments and $700 off the down payment. A week later, just before a romantic dinner at a Spanish restaurant, Debbie found her blue Z4 waiting outside.

Play the insider

To be on sound footing when you shop for a new car, you need to know how the process works -- how dealers make their money. When you zero in on a model, you want to know how much the dealer paid for it (the invoice price) and the kinds of deals that other buyers in your area are striking. If you don't have a buddy in the business, it's up to you to get up to speed. Fortunately, most of the information is easy to find (see our Car Buyer's Toolkit). If you're not up for haggling, a car-buying service, such as CarBargains, can be your advocate. Or you can turn to CarMax or another no-haggle dealership.

Ironically, the adversarial relationship between dealer and customer may have gotten worse in the past decade precisely because educated shoppers are driving harder bargains in a buyers' market. Here's the playing field: Factories are churning out vehicles to keep the production lines moving, creating surpluses on dealers' lots. So carmakers prop up demand by offering rebates or low-rate financing. Buyers are equipped with information from the Internet that lets them negotiate prices closer to invoice than to sticker price.

According to the National Automobile Dealers Association (NADA), the gross profit on the typical new-vehicle sale in 2004 was nearly $1,500, which includes profit on the financing. (Profit on used-car sales was even higher, and nearly half of a dealership's money comes from parts and service.) But by some estimates, after the dealer's expenses, the net profit on the vehicle alone is often only a few hundred dollars -- and the salesperson gets about 25% of that. So dealers try to make more money elsewhere -- on the trade-in or in the financing-and-insurance office.

Although car buyers have ready access to prices, they don't necessarily know whether they qualify for the best financing rate, or even what that rate is. "It's easier for consumers to shop the price and not bother about the loan," says Laura MacCleery, counsel for auto-safety and regulatory affairs for Public Citizen, a Washington, D.C., public-interest group. That has led to a rash of complaints being filed with attorneys general and consumer-protection agencies about the dealer reserve -- the commission the dealership receives when it inflates the lender's loan rate.

Many dealers defend the practice as fair compensation for arranging the loan. In fact, lenders sometimes approve loans for riskier customers as a way to pay back the dealer for sending business their way. But the amount of the markup is usually decided by the dealer, and that has gotten some dealers in trouble. Studies show that African Americans and Hispanics pay higher rates than Caucasians. Spurred partly by lawsuits against the automakers, legislation has been introduced in several states either to limit markups on rates or to require better disclosure.

Most dealers would rather see more education than more regulation, and are trying to police themselves. At NADA's convention in New Orleans earlier this year, ethics and improved customer relations were high on the agenda.

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