Buying a car? - Arrange your finance before you go to the dealer

A sad story ...but true

Several years ago, one of my oldest clients - let's call him John - now resident interstate - urgently needed a small cheap replacement run around vehicle ($18,000 + GST) for his business. The car was needed within 24 hours, and the dealership finance guru advised "that's not a problem" -  he could arrange the finance "on the spot at a cheaper rate than his current lender & broker could offer - "we'll make the repayments similar to what you were paying on the other car and rather than pay the $5,000 owing on the trade in from your cash at bank - we'll just include that in the deal  - and you can have the car in the morning - a win -win" 

Three years on - John's business needs had changed - the car he bought was no longer required. It had very low mileage, was in showroom condition - but at best its resale value was $10,000.

Over the 3 years he'd paid approximately $20,000 to the financier...but the payout on the loan arranged by the dealership was $19,820.96 

Lessons:

• The dealership Finance and Insurance consultant works for the dealer - not you. His/her role is to maximise the return to the dealership. Every finance deal that they settle offsets the finance charge on the dealership floorplan finance. There's no cap on the brokerage that they can build into your finance, and they can finance the shortfall on any finance owing on your trade in (see above $5,000), plus they can fund other dubious products such as paint protection, extended warranty, guaranteed payout and servicing. In Johns case the finance funded was $25,000 plus a further $1,000 plus commission.
• The interest rate on finance offered through car dealers is seldom - if ever cheaper than offered by the banks. Ask for the proposed repayment schedule - not the rate.
• Vehicle finance is usually fixed rate /fixed term over 1 - 5 years. If you pay out early, you will have to pay an early termination fee - this varies with the lender. If you only intend to hold the vehicle for 3 years arrange the finance over 3 years - it's better to pay a little extra each month than a big penalty.
• Don't maximise the balloon payment to save a few dollars on the monthly payments. If you have a balloon payment at the end of your finance term, be conservative. The object is for the payment owing on the loan to be less than the value of the car. Ignore any vague promises made by the dealer - particularly if the vehicle is a luxury make.
• Don't finance negative equity - ever. It seldom works.    
• Don't prepay / finance servicing costs. - if you need to finance service costs - you probably can't afford the vehicle....  

BMW Australia Finance required to repay $72m to customers - a historical perspective (2016)

Clients who arrange their vehicle finance through car dealerships often fall victim to questionable marketing practices that are really designed to increase the profit margin for the dealer, not necessarily benefit the car buyer. - See below

BMW Australia Finance, was required to enter into an enforceable undertaking to repay $72 million to more than 15,000 clients after being found to have breached responsible lending provisions. It's believed to be Australia's largest ever consumer pay-back scheme. The affected customers had car loans for a wide range of cars and brands, new and secondhand. (More information here).
 

Would you really lend money at 0% p.a. if you could earn 5.15% p.a.?

Periodically - although not recently due to a shortage of new vehicles and second hand vehicles selling at a premium, the papers and TV are full of ads from car dealers offering finance at rates as low as 0% - there's and old saying that if something sounds too good to be true it probably is.....

The majority of finance for car dealerships is provided by two major banks - who aren't known for giving away money at less than it costs them to borrow the funds from investors. The fine print at the bottom of the advertisement details the terms of the finance offer. What it doesn't say is that there is no negotiation in the asking price of the vehicle,  that you're paying the full list price or very close to it. Furthermore the finance term is limited  - usually to 36 months.

So how are car dealers able to offer finance at rates like 1.9% and 0% per annum? Its an old marketing trick known as subvention  - which literally means that a gift is being given...

Its simple - the car dealers financier is using the difference between the list price and the  price that you could negotiate to subsidise the finance rate. 

Who wins?   

• the dealer gets full price for the vehicle 
• the lender maximises the rate on the loan
• the manufacturer possibly gives away a little to keep the factory busy

Who loses?........... you guessed .........the purchaser! 

The moral of the story  - arrange your finance before you talk to the dealer and bargain as a "cash" buyer.
 

What will your car be worth at the end of the finance term?

Some of the biggest mistakes most car buyers make when financing a vehicle are to:

1. Overestimate the market value at the end of the finance term, and
2.  Mismatch the finance term to their holding period - i.e., finance a vehicle over 5 years and then sell the vehicle after 3 years.
3. Carry foreword a loss on the trade in of their current vehicle by adding the shortfall to the new vehicle. This becomes self-perpetuating and ultimately leads to a messy and expensive end.

These problems are more common with buyers of 'luxury" cars - who often want to stretch the budget to buy a name brand vehicle. Their buying a status symbol. A few dollars saved per month can cost $000s when the finance balloon comes due.

Do your homework - use online research e.g., Redbook. com.au to find out the lowest trade in value of similar vehicle after 3, 4 or 5 years -

Remember you're possibly also selling a vehicle with no warranty.

As at August 2022 - second hand vehicles are selling at a premium - sometimes more than their original sale price - this is not the norm.

Some old example values (from our files) of "luxury vehicles" after 5 years - Trade in figures from actual deal 

• 2013 BMW X5 Sport E 70 - Purchase Price $92,245 Trade In 2018 - $33,000 = 35%
• 2013 Land Rover TDV6 HSE - Purchase price $95,545 Trade In 2018 - $45,000 = 47%
• 2013 MB C63AMG - Purchase Price $172,400 Trade in 2018 - $68.000 = 39%
• 2013 MBC250 CDI Avantgarde Purchase Price $69,400 Trade In 2018 - $27,000 = 31.70%

The competition isn't just other secondhand vehicles. As luxury brands seek greater market share - they're not holding value as well as in the past. In relative terms many of the "newer" brands are on par with, or superior to the older established "name" brands as far as technology and build quality - they just don't have the name - yet.
 

Guaranteed future value - at what price? 

A Guaranteed Future Value (GFV) for your new car after 4 years? - Sounds like a great idea. But is it?

GFV has become a selling point for several car manufacturers, mainly prestige or upmarket vehicles that depreciate rapidly (Ie, don't hold their value well) and are sold on finance with a higher residual value / balloon at the end of the loan term than is likely to be achieved in the marketplace. 

Again its "smoke & mirrors" marketing paid for by unwitting clients.

• GFV is only available if the vehicle is financed - it's not offered by the dealer or the car maker.
• You'll have to pay full price or near full price for the vehicle - no negotiation. 
• The finance term is usually capped and there are mileage caps with penalties for exceeding the agreed kms. Most buyers forget these limitations over the term of the finance agreement and pay penalties.
• Condition of the vehicle at end of term is critical - if the vehicle suffers damage or wear and tear that's deemed (by the dealer) not to be to be fair wear and tear, the cost of repairs will be deducted from the GFV.  (In some cases, the GFV brochure extends to more than 8 pages of terms, conditions and definitions.) The dealer is the sole determinant of what's fair wear and tear and the cost of reinstatement - go figure.
• Remember that the sale price of the car includes sales tax, possibly a lot of luxury car tax, dealer charges, registration etc., these can male up as much as a third of the sale price - Drive a $160,000 car out the showroom door its trade in value immediately drops to around $106,000!!   

If your vehicle finance facility is structured correctly with a balloon value at the end of the term that's conservative and able to be achieved in the marketplace in 3 - 4 or 5 years - you shouldn't have a problem. 
 

Extended warranty, paint protection, after market options ..........

It used to be said that dealers made their money out of servicing cars - not selling them. This was based on the belief that unless you took your vehicle back to the dealer for servicing your warranty was void. This is not the case and warranty servicing can be done by most workshops - as long as they use genuine parts and follow the logbook service requirements and procedures.

After market options such as window tinting, extended warranty, paint protection etc. Finance and insurance are major income sources for the dealership. The profit margin on non-original accessories such as parking sensors is in most cases substantially more than 50% of the price charged.

• Extended warranty is an aftermarket product that is written through a general insurer and in many cases a successful claim is very difficult to establish.
• Pre-paid servicing - most car makers now offer fixed price servicing for 3 - 5 years - Why pay interest as well?
• Paint protection / upholstery protection aren't necessary if you exercise normal care and maintenance.    
• Gap Insurance - Another "must have" insurance sold by dealers covers you if the vehicle is written off and the loan payout is greater than the insurance payout on the car. If your finance is correctly structured, doesn't include spurious add on items and your general insurance is adequate - this isn't necessary.