Car Wreck - Chapter 3: How Rebates and Rental Cars Cost You Money . . . More Than You Could Ever Imagine

By Mark Ragsdale
Author / Speaker / Trainer / Consultant

The Auto Channel is thrilled to be able to present a serialized version of Mark Ragsdale's "Car Wreck" to our audience. Regardless of whether you are a consumer or an industry insider you will find this book of critical importance.
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"There is nothing so useless as doing efficiently
that which should not be done at all."

                       Peter F. Drucker
                       Writer (1909-2005)

Some vehicles today have but $600 in factory-to-dealer markup. Kia's new Forte model, built as a replacement for their Spectra model, has just $550 in total markup between dealer cost and MSRP. I have sold the Chevrolet import-fighting Aveo model, which provided less than $400 in total profit before expenses to the dealership. Who cares right? You should. Why? Because if you spend all your time negotiating discounts off of those kind of numbers, you are setting yourself up for the financial penalty of the rest of the story. What is the rest of the story? Read this edition, part 3 of my TheAutoChannel.com series.

How many consumers have purchased a new vehicle on Monday, then found out the rebates went up on the following Saturday? I have seen a particular product's rebates go up or down as much as $7,500 in that short time. I've delivered vehicles in that scenario, when customers lost money by being a little too early or late buying their new car. Of course, there was no way either the customer or I could predict whether factory incentives would go up or down, because that information is kept secret by automakers. Consequently, consumers play Russian roulette when buying rebated products-most vehicles on the market today.

The alpha and omega behind any rebate program is to help dealers move product off their lots, so they reorder inventory from the manufacturer. That's it in a nutshell. Miss the timing of these rebates as a consumer, though, and you overpay by thousands.

But the fun doesn't stop there. Every customer in the country who has purchased the model now being rebated finds himself having paid too much. Not only the consumers who bought current model year vehicles are affected. "A receding tide lowers all boats," in the words of President John F. Kennedy. This means if the price of the new ones go down by $7,500, for example, the value of one, two and three-year-old models depreciate that much faster as well. Since most vehicles are currently financed, customers' loans also go further upside-down as a result of the current rebates.

Did Jack Hill concern himself with current Mustang rebates when considering trading the car? Of course not. Like most consumers, this issue is off Jack's radar screen. But it is on ABC Motors' radar screen! New vehicle rebate increases and decreases immediately affect used car auction values. If, for example, the rebate on Model X goes up by $3,000, then every brand new Model X can now be purchased for $3,000 less. Because consumers demand similar price savings on all the used models just like it, dealers begin buying and trading used Model Xs for that much less as well. If you are among those trading in a used Model X during this time period, you lose out along with the rest of the market. Rebates cost you money.

Ironically, while rebates serve as the major mechanism by which cars and customers lose equity, banks make the situation even worse. Lenders use rebates to bury current negative equity problems into new loans. This means if a given customer is several thousand dollars upside-down in his trade, banks utilize rebates on the new car to make the new loans "look" better. How? Lenders set auto loan limits based in part on the original invoice price of a vehicle, regardless of whatever rebates are subsequently made available by the manufacturer. Lenders use these incentives to cover up their customers' negative equity problems by allowing them to effectively borrow the total invoice price plus the rebates, in order to pay off their old car loan.

This really doesn't solve customers' upside-down condition at all; it just monkeys with the numbers in order to write new loans and sell more cars. Of course, this puts the consumer in an awful position. Owing the bank several thousand dollars more than the vehicle can be purchased for makes him several thousand dollars upside-down right from the start. Shell games such as these just delay consumer pain, allowing lenders to charge more interest and turn the customer successively more upside-down each time he trades cars.

The good news: The scheme has allowed impatient consumers to get what they want, when they want it, regardless of the financial consequences. The can gets kicked farther and farther down the road each trade-in time, until the end of road is reached. This is when there is no way to get the finance transaction anywhere close to the original factory invoice. There simply are not enough rebates to play the game anymore. Those customers reaching this point get stuck; forced to keep their cars.

Do you feel like an auto industry crash-test dummy in all this? Do you feel rear-ended? Good. There's more. As voracious as rebates are in eating up your finances, rental cars hurt you even more. Not the fact that you can rent yourself a ride when you travel, but what rental cars do to the value of the one at home in your driveway.

The Devastating Effect of Rental Cars
"Fleet game" is the term I use to depict the wild deals manufacturers make with rental car companies such as Hertz, Avis, National, and Enterprise. Such programs entice these players to buy cars in tremendous volume. Volume deals move a bunch of units off the factory's back with the stroke of a pen. Automakers heavily subsidize these volume price offerings via enormous fleet rebates. These incentives virtually eclipse any normal rebates designed to motivate retail customers and their banks.

We have already talked about the market depreciation issues inherent with customer rebates. However, the real damage in the fleet game comes after automakers repurchase or buy back the used rental cars from the rental companies. That's right. The automaker guarantees to repurchase those cars from the rental company when they hit a certain age or mileage.

The time and mileage of repurchase customarily occurs within the current model year of the vehicle. This means that 2010 product is both sold as new and repurchased used within the 2010 model year. The plan allows the rental companies to project their cost of ownership during the time they will be renting these vehicles to their customers. Automakers actually offer you this type of protection when you choose to lease rather than buy your car. More on this later.

Once the manufacturer repurchases these cars from the rental companies, it liquidates them en masse at dealer auctions. Dealers purchase the auction vehicles at staggering discounts below original invoice cost and then offer them for sale to customers, on their lots, at a profit. Some of these fleet auction sales feature hundreds of current year or one-year-old, low-mileage vehicles in the same day; one after the next, after the next . . . The color selection is limited, but the supply is so enormous, the prices plummet uncontrollably.

Far more importantly to you is the hammering your trade-in value takes as a result of this glut of cars and their liquidation value prices. You can lose close to half your money buying one of these models new, the instant it is registered. When I say "lose half your money," I mean; if you finance the whole purchase and your car instantly becomes worth half of what you financed, you immediately owe the bank double what the car is now worth.

Similarly, yet far more drastically than with customer rebates, is the way in which this flood of cars devalues two and three-year-old models as well. These lower market values trickle down quickly-massively deflating the value of similar models of all ages. Just as with customer rebates, dealer and bank inventory equity positions go under water literally overnight.

The worst case of this I've ever witnessed was the 2006 Ford Taurus. Original sticker price was around $22,000 on dealer lots. Ford provided a sweetheart deal to the rental companies, bought the cars back from them, as per their contracted schedule, and sold them by the thousands at dealer auctions. At the time, a dealer could buy one of these $22,000 beauties with 12,000 miles on it for around $10,000 at auction.

In a vanishing act, all the equity of all the Ford Taurus customers disappeared. All those buyers taking delivery of a brand new one that year and the year before and the year before that got rear-ended! No matter what they paid for their new Taurus-no matter what kind of fantastic deal they negotiated with the Ford dealer-the price turned out to be too much! No dealer discount or aggressive trade-in policy could ever rival this kind of financial beating.

But the Mac Daddy move on how to "make you really upside-down" comes, once again, from the banks and their convoluted loan guidelines. Same stuff, different day in making new upside-down loans look better. They based their used Taurus loan limits around new Taurus invoice prices. This allowed them to advance up to $19,000 on each, from the car's introduction in September 2005, through April 2007. After that, the NADA (National Automobile Dealers' Association) guides began publishing 2006 used vehicle loan value averages and the jig was up.

In the meantime, dealers (like me) and our customers had a field day with these "program" cars, scooped up at auctions for fifty cents on the dollar. Dealers could buy a Taurus for $10,000, mark it up $2,000 in profit and still save the customer somewhere around $10,000 over a new one. So far, so good. However, the real damage to consumers occurred when they took advantage of the banks' liberal lending guidelines, rolling in up to $7,000 worth of negative equity. In this way, folks financed $19,000 on a $10,000 car. All this with no money down!

The wholesale market value of a 2006 Taurus was set at just $10,000, because that is what they were selling for at auction. If you were trading a 2006 Taurus at the time, you would receive no more than $10,000 for it. So all the customers were actually receiving in value was $10,000. But customers were able to finance up to $19,000 and did so, in order to re-bury their current $7,000 negative equity problems, into the newer Taurus loans. Financing $19,000 on a $10,000 car is preposterous. Loaning that money for six, seven, or eight years-insane! But that's what we did.

Fleet games are a big part of what put these car companies in the shape they are in today. Aside from a slowdown in travel and rental car use, not much has changed. Chrysler, for example, currently sells 58 percent of its production to fleet and rental companies.

Every time automakers heavily rebate a car or buy one back from the rental companies for mass auction disposal, they affect consumers like Jack and Jill Hill. They affect the value of the Mustang the couple is trading in as well as both the unpaid balance and future value of the Crossover the Hills are trying to buy.

While used car buyers, cookout stories, rebates, and rental cars are depreciating the vehicle you purchase and drive; the federal government and two-thirds of our state governments permit auto lenders the most predatory interest rate calculation method imaginable. By either act or omission, the politics behind this double-dipping is astounding. Our lending system has found a way to charge you interest twice; once on the principal balance you borrow and once on the excess depreciation of your automobile. The same government that preaches consumer protection through a series of do-nothing auto industry regulations, has allowed this rear-ending. I will teach you how this works in part 4 of our TheAutoChannel.com series.

COMING SOON: Part 4

Mark Ragsdale

www.MarkRagsdale.com
Email: Mark@MarkRagsdale.com
Business Phone: 508.299.7080
Fax: 866.299.6010

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Mark Ragsdale is author of the book Car Wreck: How You Got Rear-Ended, Run Over, & Crushed by the U.S. Auto Industry (Langdon Street Press, ISBN-13: 978-1934938652, Paperback 256 pp., $15.95). It is sold by booksellers nationwide and online. Mark has been interviewed by Fox Business Channel’s Neil Cavuto, Wall Street Journal Radio, and various syndicated news columnists. For more information about the book or author visit www.MarkRagsdale.com.

SEE ALSO: The Auto Channel's 4 Steps to become a smarter car buyer