Front End and 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 guidebook. “Back-end” profit is generated primarily 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 is 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 his new car at the dealership and the dealer arranges a $20,000 loan structured for 60 months at 8% interest, which results in a $406 monthly 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 a customer at 8%, the payment is $20 more than if the loan was calculated at the 6% “buy-rate.” Over 60 months, that extra $20 equals a total of $1,200 profit. This profit is called the Finance Reserve.
Usually, the dealership does not receive the entire “Finance Reserve” profit; typically, they receive 60% to 80% of the total. In the example above, the dealership is clearing $700 to $900 of hidden back-end profit from the customer. You will be able to calculate this back-end profit automatically with our Cheat Sheets. One thing to keep in mind is that on most finance deals, the bank will require the dealer to refund the finance “back-end” profit if the customer pays off the loan early. Thus, if the customer pays off the loan within a few months of the purchase, the dealer will have to return 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 referred to as the Money-Factor. For example, the money-factor on a lease may be 0.0375, and the buy-rate could be 0.0275. 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 off 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 example, 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.
Example of the “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 by a small amount. $20,000 loan for 60 months + $1,500 for paint sealants = $21,500 - 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 by only $10 to $416 and sell the sealants for $1,500.
In the earlier example, the buy-rate is 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 into a payment to sell back-end products is called a “Leg.” Normally, for example, if you were to add $1,500 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 a $1,200 “leg” in the payment, the F&I manager can now charge $1,500 for paint sealants and tell the customer it will only change their payment by $10, making it $416.
Example of a car dealer’s “back-end” profit that is generated from the buy-rate:
$20,000 loan for 60 months
8% (What the customer pays for the loan) = $406 per month
at 6% (Buy Rate - What the car dealer pays for the loan) = $386 per month
Dealers “leg” (the amount of the dealer's profit per month on the loan) = $20 per month
In this example, the dealer has a $20 “leg” that produces $1,200 in extra payment, of which the dealer could receive $700 to $900 of back-end income from the bank.
Example of the “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 by a small amount.
$20,000 loan for 60 months
+ $1,500 for paint sealants
= $21,500- 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 by only $10 to $416 and sell the sealants for $1,500.