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(Excerpted from Stop Getting Ripped Off) Sometimes it’s easier to explain things by describing their opposite. So here’s a fictional account of a perfectly terrible way to buy a new car..
John Nay-Eve has been driving a 1997 Ford Mustang from his college days for about 10 years. About every 6 months he drops $500 on repairs, gets mad, but then gets his car back from the mechanic and goes on with his life. But one Friday night, as he’s about to go on a date with a co-worker – a date will Jill that he’s been eyeing for months – the car starts making a hideous knocking noise on the way to her apartment. For a moment, John ignores the sound, as he’s running late. But the noise gets louder, and louder, and louder, until finally, the car lurches a few times and shuts down. John coasts to a stop on the shoulder, and smoke starts to billow out from the under the hood. He calls up Jill and makes his apologies. From the sarcastic sound of her voice, John figures he won’t get another chance with her. “Great,” he says to no one in particular. “That’s it. Tomorrow I’m getting a new car.” So Saturday morning, he grabs his latest Mustang Lovers magazine and his checkbook, and he takes the bus to the nearest Ford dealership. As he hops off the bus, which conveniently stops right at the dealer’s front door, he sees a flurry of activity. Men in white shirts and ties scurry about. There’s a table in the middle of the showroom with a couple sitting and signing papers. And near the front door are a line of convertibles in so many colors it looks like a fruit stand. John drifts right over to the red one. “Jill will go out with me if she sees me in this,” he thinks. Within a few seconds, he hears a friendly voice. “Beautiful aren’t they,” says a man in a raspy, cigarette-aided baritone. John whips around to see a burly man with a receding hairline, hairy arms, and overpowering cologne. “That one’s a chick magnet. You’re a smart man. If I was your age, I’d have to have one of these.” By now, Mr. Salesman has already spotted John’s checkbook, popping out from the top of his shirt pocket. “We only have one of those,” Mr. Salesman says. John looks around and sees perhaps a dozen red Mustangs nearby, but says nothing. “In fact that couple over there was just looking at it. We can take a test drive, but I’m not sure it’ll be for sale by the time we get back.” They hop in the car. Mr. Salesman drives first. He rolls down the windows, cranks up the radio, and floors the gas. “That’s 190 horses of power!” he shouts. “And the biggest rush you’ll ever feel outside of, well, you know what. But we can help you get that, too!” They get to a parking lot a mile from the car lot. Mr. Salesman tells John it’s his turn to drive. “Wow,” John thinks. “This is such a nice guy. He trusts me with this $28,000 car and his life! He must be a good man.” John slips into the driver’s seat and holds the steering wheel tight, like a child holding onto a ferris wheel guard rail. Then he steps on the gas and grins unabashedly. While the two men drive back to the dealership, John hears a soliloquy about the benefits of the “all-new” Mustang. Leather steering wheel. Sport rims. New, ergonomic dashboard. Four cupholders. And power, power, and more power. When they get back to the showroom, Mr. Salesman asks John to pull the car right up to the front door. When they park, he says simply, “C’mon inside,” and walks into the showroom without looking back. John, not wanting to be impolite, follows. A cute girl in a tight skirt sitting at the front desk smiles at him as he walks by. “Nice wheels,” she says and smiles, before answering the phone. John sits at a round table nearby. The salesman offers him a Coke, which he accepts. A flurry of announcements blare over the loudspeaker. The cute girl makes one: “Mr. and Mrs. Monohan, your neeeeeeew car is ready.” Just as she says that,a big blue Ford Escape comes slowly rolling into the showroom, backwards. A valet gets out, hands the couple the keys, and they get in. Sales staff gather ‘round and applaud. The couple drive out through the huge double doors. Mr. Salesman re-emerges and breaks the moment. “That’s lucky kid. She talked him out of the Mustang. Be glad you’re not married. Ha!” he says. “You can have that sweet baby if you want it. You’ll need to act fast, though. What can you afford each month? Let’s figure out how to get you into that car.” John thought about his finances a little on the bus. He makes about $3,500 per month. After taxes, he takes home about $600 each week. After rent and the other basics, he has maybe $800 left over each month. He figures he can spend maybe half of that on a car payment. “About $350 each month,” John blurts out. He figures he’s bargaining hard. “And I have a trade in.” Mr. Salesman, meanwhile, isn’t looking at John. He’s banging away at a calculator and then putting numbers on a piece of paper. In one corner, he writes $30,040. In another corner, he writes $745.33. In another, $8,000. Then, he looks up. “Tell me about your trade in, kid. I noticed, you took the bus.” John tells the long story about the date with Jill, and the smoke, and the tow truck from the night before. Mr. Salesman hardly looks up. “You know, we might only get $200 for a car like that at auction. But I’ll give you a break,” he says, and writes down $1,000 on his piece of paper. Then he crosses out $8,000 and writes, $7,000. Then he shows the sheet to John. “OK, simple. You come up with $7,000 and this car is yours today. And there’s your monthly payment. Can you write a check for $7,000?” he asks and points a pencil right at John’s checkbook. John, who has about $3,000 in his checking account, swallows hard. Questions he knows he’s supposed to ask swirl around his head. What is the interest rate? Why is the price more than the $28,000 he saw on the sticker? What happened to $350 a month? But he can only muster one thing: “No, I can’t. That’s too much.” “Hmmm. Too rich for you, eh? Well, I like you kid, let me see what I can do for you.” At that point, Mr. Salesman disappears and leaves John sitting at the table, his new red Mustang in full view. And he waits. And waits. Ten minutes, fifteen minutes. Several people walk by his red car and size it up. Twenty minutes. Finally, Mr. Salesman returns. “Great news. This just in. There’s a $3,000 factory rebate on that car beginning Monday. But if we write the paperwork correctly, we can give it to you now and apply it to the down payment. That brings the down payment down to $5,000. What do you say kid?” By now, the reality of a $745 per month payment has set in. With insurance and gas, transportation would take up nearly half of his take home pay. He just can’t do it. “Well, the down payment I can hit,” John says, imagining he can use a $2,000 credit card cash advance to supplement the $3,000 he has. “But I can’t make that monthly payment. I thought we were going for something closer to $350 per month. “Umm, $350 a month? Up to what?” the salesman says. “Up to, ummm….” “Because all that would get you is this white Ford Focus over here,” the salesman interrupts, pointing to a two-year old compact car sitting by the car wash. “Up to, I guess $450. Maybe, maybe $500,” John says. The salesman pencils $500 down on his sheet. “OK, let me talk to my manager. But you’re putting me in a tough spot,” he says. Another long pause. Now, it’s lunctime, and John is starving. All he can think about is pulling up to a drive-through McDonald’s in that red Mustang and ordering a hamburger. Another twenty minutes pass. “Great news. I think we have a deal,” Mr. Salesman says. “Your new payment is $650.44. It took a lot of talking, but I got my manager to come way, way down on his price, almost $100. Do we have a deal? Just initial here.” John slumps. His stomach growls. He still can’t afford that. “Isn’t there any way to get that closer to $500 per month?” he asks, sheepishly. This time, Mr. Salesman has another answer. “Well, there is one thing. We could spread you out a little,” he says. He grabs his calculator and taps away. Suddenly, the salesman’s face lights up. “Oh, you’re going to like this,” he says, and scribbles a number on the sheet. “Look at this!” He passes the paper over to John. It reads: “$549.43/60.” “If we spread the payments out over 60 months, you can drive away in that baby for $549.43 a month.” John looks over at the car. “Now c’mon, John. We are right in the middle here. You said $350, we said $750, and $550 is right in the middle. You’re never going to get a better deal than that.” ****
The perils of car buying are familiar to nearly everyone; and nearly everyone has a car-buying horror story. Hopefully, the one you have will be your last. Thanks to the Internet, the balance in power of car shopping really has shifted towards consumers. It’s so easy to get pricing information, making it so hard for dealers to get premium prices. In fact, the process of buying a new car lands you into a rare marketplace that is about as pure as any you’ll find. Similar to airline tickets and books, the Internet has made it possible to compare prices for essentially the same product from dozens of car retailers nearly instantly, creating what economists call a “flat” market, or a race to the bottom on price. Sellers, understandably, hate this. And they aren’t standing for it. Retailers in these deeply competitive environments have fought back like wounded animals. In 2008, we saw the airline industry add one absurd fee after another, as if they were engaging in strange competition for deepest irony. Finally, some airlines were charging for water and pillows (yup – JetBlue had a $7 pillow fee). But that’s child’s play compared to the way car dealers have lashed out in response to the Internet. There’s an overriding principal you should keep at hand as we discuss car buying: thanks to intense competition, dealers really do make very little profit through the straightforward sale of a car at a price you can find through the Web. In some cases, they make only the “dealer holdback,” a bonus given to the dealer by the automakers at the end of the year. That’s a meager way to run a business. This necessitates stealing from consumers in other ways. Car dealerships simply wouldn’t stay open if they didn’t trick buyers into overpaying during some other part of the deal. So the image you should keep in mind is this: car salesman have one job, and one job only. They want to “up” you at every turn, and grab money out of your wallet. Their survival depends on it. Your job is to stop them. By the time we’re done, I hope you will be wondering to yourself why you would be asked to rescue such an industry. Not only does it constantly border on fraud, but it’s the poster child the problems of a market that’s run on the Gotcha Capitalism system. Fairness isn’t only good for consumers; it’s good for companies too. Industries that survive on lies eventually implode. That’s the fatal flaw behind the failed U.S. car market. **** You probably know what happens next in John Nay-Eve’s story. If John still balks, he’s told his only remaining option is to lease the car; but that’s an even better deal! For only $2,000 down and $439 a month, he could lease the red Mustang for three years. That sounds so much better than the original $7,000 and $750 per month that John’s defenses are completely worn down. He gives in and drives away in the car, then decides he can only afford a 99 cent burger at McDonald’s. Many negotiating techniques in this story will be familiar to you. Salesmen will often try to slowly worm their way into your good graces and then slowly sweeten their deal with add-ons like undercoating or extended warranties. This is sometimes called the “Foot in the Door” strategy. The hope is – like a frog that doesn’t notice water as it’s slowly brought to a boiling point – the shopper will go in looking for a $15,000 car and leave buying a $20,000 car. The opposite strategy – loving called by economists the “Door in the Face” tactic – is also present here. In fact, it’s a bit more obvious. The salesman aims high – very high – going for shock value. After a $745-a-month payment is put on the table, almost anything would sound good to our Mustang buyer. John, of course, has engaged in a long comedy of errors. And unlucky for him, he’s encountered a professional salesman who knows every trick in the book. If John had a little larger bank account, for example, you can bet he would have unknowingly surrendered part of that $3,000 rebate that mysteriously appeared. As it is, John didn’t balk at the salesman’s “arithmetic error,” and was about to give away $1,000 without batting an eye. As careful readers, you probably thought I’d made a mistake when the salesman dropped a $7,000 down payment to $5,000 after applying a $3,000 rebate. Instead, I simulated a common money grab that dealers frequently employ. I have purchased four new cars in the last 10 years. Every one of the negotiations has included such an arithmetic error. In one case, a dealer tried to absorb en entire $1,500 rebate for himself by ‘miscalculating’ my monthly payments. In another, lease payments were off by $30 each month. I assure you, these are not errors. Let’s look at some of the other basic mistakes John made. • He went shopping for a car when the need was urgent. You always want to buy when you don’t have to buy. • He bargained on monthly payments instead of purchase price. This is the biggest mistake car buyers make. Notice the dealer reached the “compromise” of $550 per month by simply making John take out a longer-term loan. That’s a terrible way to “make the numbers work” when buying a car. John will be on the hook for this bad deal for five years! • He hadn’t done the math before he left his house. Always arrive at a dealership with broad numbers in mind – a $10,000 car loan for 48 months at 6.5 percent costs about $200 per month. A $20,000 loans costs about $400 a month, and so on. When scratching out a rule-of-thumb calculation, work in sales taxes and fees, too. That’s about another $25 per month for every $10,000. Such rough guideposts will keep you from getting severely screwed. • John let the dealer do the math for him, and unknowingly agreed to a 12 percent interest rate. Even with the stolen rebate and other hideous terms, John could have paid nearly $100 less each month with a prevailing rate interest loan. • Here’s another cardinal sin: He let the dealer arrange the financing for him. Always show up at the dealer with pre-arranged financing from your bank or credit union. That will make it a cash deal, and take away one major area for potential mischief during negotiation. • He muddied his deal with a trade-in when he had no idea what the value of his car was. In this case, $1,000 sounds like a good price, but in reality, the dealer just overcharged him in another part of the deal. Many people know that they will get much more money from a private sale of a car than from a trade-in at a dealer. That’s true, but my chief concern is not your trade-in profit: it’s avoiding confusion. Car sales staff will tell you that trade-in shenanigans are one of their biggest profit centers. Everyone likes to think they got a good deal from the dealer on their trade in. When they do, it almost always means they were overcharged for the car. • John didn’t shop around on price, and accepted the “second sticker.” He actually paid more than MSRP. The second sticker is merely the amount an auto dealer marks up a car above MSRP – the sticker price, manufacturer’s suggested retail price - in the hopes of skimming extra profit. In rare cases, a car is so popular and in such demand that dealers actually can charge premium prices – for example, the Toyota Prius hybrid during the 2008 gas price crisis. But generally these are mere wishful thinking, and part of the “aim high” strategy many dealers follow, the numbers framing we described in the introduction. When you throw out a high number, it raises the “middle ground” number which becomes part of the bargaining later. Ignore second stickers when negotiating. Remember, if a car is actually sitting on the lot, it’s not really in high demand. • He went shopping on a busy Saturday. Generally, you’ll do better when you go during a slow weekday. Yes, it is worth a vacation day – or two, or three -- to get a good deal on a car. Often, you can get a better deal by shopping at the end of the month, too, when sales bonuses and other incentives are on the line for dealers. • And he planned on using credit card cash advances to supplement his down payment. That’s a terrible idea! If you’re struggling to make monthly payments, you’ll obviously struggle to make credit card payments, too. And the interest rate on those could be three or four times higher! Here’s the bottom-line tragedy of deals like the one John made. A fair price for the Mustang he bought would have been fairly close to his original offer. At prevailing market prices of $26,000, plus the full rebate and another $5,000 down (a combination of cash and trade-in value), John could have paid $385 per month for 48 months. But how would John be sure to get the best price?
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