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How Car Financing Works

At the Dealership

­ W­hen you finance through the dealership, you have to remember that the Finance and Insurance (F&I) department is often a bigger profit center than the sales department. The business manager (the person you deal with in the F&I department) sends your credit information to the lender(s) they deal with. The business manager then takes the lowest approved interest rate and marks it up (increases it). The marked-up amount is the dealership's profit on the financing. There is no law saying the dealer has to reveal that mark-up to you. This is why you have to keep your negotiating hat on throughout the process! This financing is really just another product the dealership sells, known as a Retail Installment Sales Contract (RISC).

Special Incentives
You're watching your favorite late-night TV show, and between the shampoo and fast-food commercials you see a car ad that offers zero-percent interest or a $2,000 rebate on a car you've been thinking about buying for months. Wow! What a deal! You have to get to the dealership now! So the next day, you do just that.

Factory-to-Consumer Rebates
First, let's find out what those offers mean. With the factory-to-consumer rebate, there really is no catch. These are rebates the car manufacturer offers directly to you as an incentive for you to buy a specific car. They offer them when they see a larger number of that particular car sitting on car lots than they would like to see. So, in order to move the cars off the lots (i.e., get people to buy them), they offer the rebate. The rebates are not part of the dealer's package and shouldn't even come into play when you're negotiating the sales price with the salesperson. Don't let them try to use the rebate as a way of making the purchase price lower. You have the choice of applying the rebate to your down payment (or not). As Michael Royce says on his Web site, Beat The Car, "Take the money and smile."

0% APR
Zero-percent interest? Who wouldn't jump at that? And you should jump at it if you can handle the term. Often (but not always), in order to get zero-percent financing, you have to agree to a shorter term loan, sometimes 24 or 36 months. This means your payments are going to be quite high. Of course, it also means you'll have the loan paid off relatively quickly (compared to the more common 48- to 60-month term). Here are few other things that may come between you and that zero-percent rate:

  • In addition to the usual shorter term of the loan, you have to qualify for that rate. In most cases, if your credit score is lower than 680, you won't be able to get the lowest rate.

  • You may be limited to buying from what's on the lot, rather than being able to order a car with the exact features you want.

  • Know that by going for the low interest rate you usually lose the cash rebate. It's one deal or the other -- not both.

In many cases you're better off taking the rebate and financing elsewhere at a higher rate:

2.9% Dealer Financing
Take the Rebate & Finance Elsewhere
Vehicle Price
Trade-in Value
Amount Financed
Term (months)
Interest Rate (APR)
Monthly Payment
Total Cost of Loan (P&I)

To figure out which is the better deal between taking the cash rebate or the low APR, use this calculator at Don't forget to try the same calculation taking the rebate and financing with your bank or credit union. Also, read about How 10% Can Beat 0% at the Consumer Task Force for Automotive Issues Web site.

For a list of current rebates on specific cars, check out Intellichoice: Rebates and Incentives.

Recent Graduate Programs
Many car manufacturers offer a special "recent college graduate" program that gives new graduates a discount on the purchase of a new car. The savings is usually around $400. Each manufacturer may have different rules. For instance, some have rules about excluded models and selecting a car from dealer stock. Be sure to ask about it if you're a recent graduate. (Recent, for most manufacturers, means within the last two years. Double check that when you're shopping.)

The smart thing to do is to visit the manufacturer's Web site before you go to the dealership so you know what special deals are being offered directly from the manufacturer.