Car Dealer's Back End Profit

Car Dealer's Back End Profit
The terms “Front-End” and “Back-End” describe two different categories of dealer profit.  The “front-end” profit is the income made from the sale price of the vehicle. This is the difference between the vehicle’s cost and the selling price. 
For example, if the dealer sells a car for $20,000 and their cost is $17,000, this will produce a $3,000 “front-end” profit for the dealer.
The “back-end” is profit generated from financing, leasing and the sale of “extras” added to the car. The dealership’s “back-end” profit is one of the important topics in this guide book.
Mostly, “back-end” profit is generated when a customer finances or leases a car from the dealership. This financing is based on an interest rate that is revealed on the loan or lease agreement.  However, what is not disclosed (and not required to be disclosed) is that the dealership is charging the customer one interest rate while they are buying the loan or lease at a cheaper rate from the bank. This cheaper rate is called the Buy-Rate.
For example, a customer finances their new car at the dealership and the dealer arranges a $20,000 loan structured for 60 months at 8% which produces in a $406 month payment. 
What is not disclosed is that the dealer “buys” that loan from the bank at a rate of 6%, not 8% and is making 2% on the loan. Therefore, by offering the loan to customer at 8% the payment is $20 more than if the loan was calculated at the 6% "buy-rate".  Over 60 month’s that extra $20 equals a total of $1200 profit. This profit is called Finance Reserve.

The back-end is profit generated from financing; leasing and the sale of “extras” added to the car...

Usually, the dealership does not receive the entire “Finance Reserve” profit; they will usually receive at 60% to 80% of the total. In the example above, the dealership is clearing a $700 to $900 of hidden back-end profit from the customer. (You will be able to automatically calculate this back-end profit with our Cheat Sheets in the Calculations Chapter .)
One thing to keep in mind, on most finance deals the bank will require the dealer to refund the finance “back-end” profit if the customer pays of the loan early.  In other words, if the customer pays off the loan within a few months of their purchase, the dealer will have to give back the “back-end” profit they earned on the interest rate.

Dealerships also have buy-rates for lease contracts. On a lease contract the buy-rate is the Money-Factor.

For example, the money-factor on a lease may be .0375 and the buy-rate could be .0275.  These "back-end' lease profits can be very substantial and unlike the finance contract, the dealer does not have to refund the bank if the customer pays of the lease early. (The lease reserve can also be calculated on our Lease Cheat Sheet ).
Because the car dealer may have to refund the bank their "Finance-Reserve", they will always try to convert that “back-end” profit into some non-cancelable products.  For instance, if there is $20 built into the payment, instead of collecting the $700 to $900 in profit from the "finance-reserve", the dealership will try to use that extra money to sell something like paint sealants. 
In the earlier example, the buy-rate is at 6% and allows an extra $20 to be hidden in the payment.  The “F&I” Manager can charge the customer more money for "extras" and only increase the payment by a small amount. This act of building room in a payment to sell back-end products is called a “Leg”.
For example, normally, if you were to add $1500 in paint sealants  to a finance contract, the customer’s payment would change from $406 to $436 per month (a $30 increase).  However, because there is $1200 “leg” in the payment, the F&I manager can now charge $1500 for paint sealants and tell the customer it only will change their payment by $10 making it $416.

Example of a car dealer’s “back-end” profit that is made from the buy-rate:

$20,000 loan for 60 months
8% (Rate) = $406 per month
6% (Buy Rate) = $386 per month
Dealers “leg” = $20 per month
In this example, the dealer has a $20 “leg” that produces $1200 of extra payment, of which the dealer could receive $700 to $900 of back-end income from the bank.

Example of that “back-end” profit converted from “buy-rate” profit into the sale of paint sealants:

The dealer could sell some products (like paint sealants or warranties) and only change the payment a small amount.
$20,000 loan for 60 months
+          $1500 - for paint sealants
=          $21500 - Total
8% (Rate) = $436 per month
Dealer “leg” - $20 per month
New payment = $416 Payment
Instead of presenting a payment of $436, the "F&I" Manager can present a payment that changed only ten dollars to $416 and sell the sealants for $1500 dollars.
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