Beware of Dealership Floor Plan Financing: Understanding the Risks for Car Buyers

How does a dealership’s floor plan impact auto sales and consumers? Let’s start by defining what a floor plan is. It’s a specific type of credit that dealerships use to finance their inventory. Most dealerships have floor plan financing in place for their car lot. For instance, if you pass by a new or used car dealership and see a hundred or even fifty cars parked outside with an average price of $20,000 to $30,000 each, you’re looking at millions of dollars worth of inventory just sitting there. However, most dealerships don’t have millions of dollars in cash on hand to purchase inventory outright. Instead, they obtain a credit line, similar to a large credit card, that they use to buy vehicles. 

How does dealer floor plan financing work?

Here’s how it works: when they attend auctions to buy inventory, which is where most dealerships get their cars, the auction is connected to their floor plan. When they buy a car for, let’s say, $25,000, they simply sign for it, and it goes on their line of credit. The line of credit then sends a wire transfer for that $25,000 to the auction. The dealership then takes the car back to their lot, fixes it up, cleans it, and puts it up for sale.

When a dealership sells a car, they must first pay off a portion of the line of credit by doing a buydown for the first amount of the sale; usually, the price paid for the car, such as $25,000. The remaining profit, which could include additional fees for things like shipping or auction fees, is kept by the dealership. However, if the dealership is experiencing financial difficulties and needs cash, they may be tempted to delay paying off their line of credit by using the cash received from a car sale. This delay could prevent the dealership from obtaining the car title, which is held by the floor plan lender until the loan is paid off. As a result, the dealership will be unable to transfer the title, register the vehicle, or issue a license plate to the customer, leaving them in limbo. Ultimately, this delay could negatively impact the consumer’s experience.

Let’s assume that a dealership buys a $25,000 car using a loan that incurs interest payments. A few years ago, the interest rates were low, only 1% or 2%, and it might have cost a couple of hundred dollars per month to keep that car on the lot. However, with the current spike in interest rates, it could cost around $400 or $600 per month, adding up to an additional $2,000 of expense after three months on the lot. With the original $25,000 principal amount, the total tied up in the car is now $27,000. Suppose the market drops and a customer offers to buy the car for $23,000, which is less than what the dealership invested. In this case, the dealership will need to pay off the $25,000 loan plus the additional $2,000 in interest, totaling $27,000, despite only receiving $23,000 for the sale. This means that the dealership will be out of pocket by $4,000 if they sell the car under these circumstances.

If a dealership is experiencing financial difficulties, they may not be able to come up with the money to pay off the loan, which means they are better off keeping the car. However, keeping the car does not solve the problem, as its value will continue to decrease every month, adding up to more interest. This situation can negatively impact consumers, who may wonder why cars are not being sold at used or new car dealerships. They may assume that the dealership is aware of the car’s true value and wonder why they don’t just sell it at a lower price. However, the reality is that the dealership may not have the cash to pay off the loan and may have negative equity in the car, meaning they owe more than the car is worth. This situation is particularly challenging for used car dealerships with thin capitalization, as they may not have the funds to cover the difference. Even on a $25,000 car, the loss could be as much as $2,000 to $3,000, but on higher-end dealerships that sell luxury or high-end cars priced at $40,000 or $50,000, negative equity could be as high as $8,000 to $9,000. In such cases, the dealer may get stuck with the car, which can ultimately affect consumers in a variety of ways.

When you buy a car from a dealership, there are potential consequences that could affect you, such as delayed receipt of the title or paying the wrong price for the car. Additionally, if you trade in a vehicle that still has a loan, you’re relying on the dealership to pay off the loan, as per the agreement. However, if the dealership is experiencing financial difficulties and can’t cover expenses like payroll, they might not pay off your loan right away. We’ve seen cases where dealerships made car payments for customers who traded in their cars but didn’t pay off the loan immediately. If the dealership doesn’t make the payments, it could result in late fees and a delinquent record. In the worst-case scenario, the dealership goes out of business, and you’re left with the debt. The problem with dealership floor plans is not only affecting car dealerships, but it is also having an impact on consumers. Some cars are sitting at the auction for weeks, causing the book value to drop. The dealerships may be stuck with these cars and unable to sell them without coming out of pocket thousands of dollars, which they may not have due to the market turning against them.

Expert Automotive Advice At Your Fingertips.

Get expert advice for buying or selling your car with TelAdvice.com. Our team of automotive experts can provide you with tailored advice to navigate the process with confidence. Schedule your consultation today and take the first step towards a stress-free buying or selling experience.

https://cartitles.com/wp-content/uploads/2023/03/teladvice-logo-transparent-300×165.pngTalk to an Expert