Chapter 22 — Quiz: How Auto Financing Works

Answer each, then expand the <details> block to check yourself. Scoring guide at the end.

Multiple Choice

1. When a customer "finances through the dealership," what is the dealer's actual role in most retail car loans?

  • A. The dealer lends its own money and sets the rate
  • B. The dealer is a broker who shops the loan to lenders and presents an approval
  • C. The dealer guarantees the loan if the customer defaults
  • D. The dealer only processes paperwork for the customer's own bank
Answer**B.** The dealer is an *indirect lender* — a broker. It submits the application to banks, credit unions, and captives, and presents the best approval. It does not lend its own money on a typical retail loan.

2. The buy rate is best defined as:

  • A. The rate the customer signs and pays
  • B. The rate the dealer marks the loan up to
  • C. The rate the lender will fund the loan at (the dealer's wholesale cost of the money)
  • D. The advertised "from" rate in the manufacturer's ad
Answer**C.** The buy rate is the lender's rate to the dealer — the wholesale cost. The customer signs the *sell* rate, which is usually higher.

3. Dealer reserve is:

  • A. Money the dealer sets aside in case a customer defaults
  • B. The dollars the dealer earns on the spread between the sell rate and the buy rate
  • C. A fee the lender charges the dealer
  • D. The customer's down payment held in escrow
Answer**B.** Reserve is the dealer's profit on the financing — the spread (sell − buy), turned into dollars. It is the financing half of back-end gross.

4. A lender quotes a 6.4% buy rate and the finance office offers the customer 7.9%. The dealer reserve, in rate terms, is:

  • A. 7.9%
  • B. 6.4%
  • C. 1.5 percentage points
  • D. 14.3%
Answer**C.** 7.9% − 6.4% = **1.5 percentage points** of markup, which becomes the reserve in dollars.

5. Which lender type is most likely to offer a subsidized 0–2.9% APR special on a new car?

  • A. A national bank
  • B. A credit union
  • C. The manufacturer's captive finance company
  • D. A subprime specialty lender
Answer**C.** Subsidized low-rate specials come from the **captive** because the *manufacturer* buys down the rate to sell cars. Banks and credit unions have no reason to lend at 0%.

6. In the payment formula M = P·r·(1+r)^n / [(1+r)^n − 1], the variable r represents:

  • A. The APR as a whole-number percent
  • B. The monthly interest rate (APR ÷ 12, as a decimal)
  • C. The number of payments
  • D. The amount financed
Answer**B.** r is the *monthly* rate — the APR divided by 12, expressed as a decimal (e.g., 6.9% → 0.069/12 = 0.00575).

7. A customer asks you to lower their payment. Which lever lowers the payment without increasing total interest?

  • A. Lengthening the term
  • B. Accepting a higher rate
  • C. Increasing the down payment (or trade equity)
  • D. Rolling in negative equity
Answer**C.** A bigger down payment (or more positive trade equity) lowers the *amount financed,* which lowers both the payment and total interest. Lengthening the term lowers the payment but *raises* total interest.

8. The amount financed on a deal equals:

  • A. Selling price + tax + fees
  • B. Selling price − down − net trade equity + tax + fees
  • C. MSRP − rebates
  • D. Monthly payment × number of months
Answer**B.** Start from the selling price, subtract cash down and net trade equity (positive equity reduces it), then add sales tax and fees.

9. Why did regulators push the industry away from discretionary dealer rate markup?

  • A. It made loans too cheap for dealers to profit
  • B. Deal-by-deal discretion produced disparate-impact patterns where some groups paid higher markups on average
  • C. It violated the manufacturer's warranty
  • D. It made APR disclosure impossible
Answer**B.** Unlimited discretion over markup, deal by deal, produced unfair patterns (disparate impact) even without intentional discrimination — a fair-lending (ECOA) concern. Flat/capped, non-discretionary policies address it.

10. A customer should compare two loan offers primarily by their:

  • A. Monthly payment
  • B. Term length
  • C. APR (and total of payments)
  • D. Down payment
Answer**C.** APR is the all-in, apples-to-apples cost. A lower *payment* can hide a longer term and more total interest, so payment-to-payment comparison is misleading.

11. On the Okafor deal (amount financed $41,030, 72 months), moving from a 6.9% buy rate to a 7.9% sell rate costs the customer approximately:

  • A. About $2 per month
  • B. About $20 per month (~$1,428 over the loan's life)
  • C. About $100 per month
  • D. Nothing — the rate is the same to the customer
Answer**B.** $717.39 − $697.55 ≈ **$19.83/month,** about **$1,428 over 72 months** — which becomes ~$1,000 of dealer reserve.

12. A customer with a 545 credit score falls roughly into which tier?

  • A. Super-prime
  • B. Prime
  • C. Near-prime
  • D. Deep subprime
Answer**D.** Below ~580 is **deep subprime** — the highest rates, fewest lenders, largest down-payment requirements. (Devon Wallace, around 580, sits at the subprime/deep-subprime line — [Chapter 26](../chapter-26-subprime-special-finance/index.md).)

True / False (give a one-line justification)

13. The dealership lends its own money on most retail car loans.

Answer**False.** The dealer is a broker; real lenders (banks, credit unions, captives) fund the loan. The dealer arranges it and earns reserve.

14. Rate-shopping with several lenders in a two-week window generally counts as a single inquiry for credit-scoring purposes.

Answer**True.** Scoring models bundle auto-loan inquiries within a short window into one inquiry so buyers can comparison-shop without being penalized.

15. Lengthening the loan term lowers the monthly payment and lowers the total interest paid.

Answer**False.** It lowers the *payment* but *raises* total interest (and keeps the borrower in the loan — and any negative equity — longer).

16. A finance manager who marks up every customer to the lender's maximum allowable cap is acting ethically as long as it's within the cap.

Answer**False.** "Within the cap" is not the same as "right." Maxing the markup on everyone — especially the unsophisticated — is exactly the discretionary, disparate-impact pattern fair-lending rules target. Consistent, disclosed, capped policy is the standard.

17. APR and interest rate are the same number.

Answer**False.** APR is the all-in annual cost including certain finance charges/fees; the interest rate is just the cost of the principal. APR is the truer comparison number.

18. A credit union is often the best non-subsidized rate for a prime customer.

Answer**True.** Credit unions are not-for-profit and member-owned, so they frequently pass savings to members as lower rates — the rate to beat when no manufacturer special is in play.

Short Answer

19. In two or three sentences, explain the broker model to a nervous customer the way you'd actually say it on the floor.

AnswerStrong answers convey: we're not the bank; we shop your application to many lenders (including possibly your own) and find the best approval; we arrange the loan, we don't make it; and that's faster than you calling lenders one by one. Bonus for inviting comparison.

20. State the monthly payment formula and what each of the four variables means.

Answer`M = P·r·(1+r)^n / [(1+r)^n − 1]`. **M** = monthly payment; **P** = amount financed (principal); **r** = monthly rate (APR ÷ 12, as a decimal); **n** = number of monthly payments (term).

21. Name the three "levers" that change a monthly payment, and one consequence of pulling each.

Answer**Term** (longer → lower payment but more total interest, longer underwater); **rate/APR** (higher → higher payment and more interest — the buy/sell spread in dollars); **amount financed** (more down/equity → lower payment *and* less interest — the honest lever).

22. Why does telling a customer "go get a credit-union quote and let me try to beat it" usually help the salesperson rather than hurt them? Give two reasons.

AnswerAny two of: the dealer often still wins (convenience + competitive rate, and the dealer's lender list may include the customer's bank); a customer who feels they got a fair shake signs relaxed and is open to F&I products instead of fighting; it builds trust and referrals worth far more than one reserve; it's the trust-and-referral model out-earning the grind (Themes #3, #5, #6).

23. What is back-end gross, and what are its two sources? Tie it to the Okafor deal.

AnswerBack-end gross is profit made in F&I *after* the car is agreed on. Two sources: **dealer reserve** (financing spread — this chapter) and **F&I product margin** (ESC, GAP — Ch 24). On Okafor, the front made ~$200, but the financing reserve made ~$1,000 — the back end carried the deal.

Applied Scenario

24. A customer is financing **$24,000 at 8.0% APR for 60 months.** (a) Compute the monthly payment, showing r, n, (1+r)^n, and M. (b) State the total interest. (c) The customer says "I need to be under $400." Propose one honest lever to get there and state its consequence.

Answer(a) r = 0.08/12 = 0.0066667; n = 60; (1.0066667)^60 ≈ 1.489846; M = [24000 × 0.0066667 × 1.489846]/[0.489846] ≈ 238.38/0.489846 ≈ **$486.62/month.** (b) Total of payments = $29,197; total interest = **$5,197.** (c) Honest options: stretch to **72 months** (M ≈ $420 — still not under $400, so also need more down) — *consequence:* more total interest; or put about **$4,000 down/equity** to finance ~$20,000 (M ≈ $405) and combine with a slightly longer term — *consequence:* needs cash but lowers true cost. Whatever lever you pull, show it; don't quietly stretch the term.

25. On the showroom floor, a customer asks, "What's my interest rate going to be?" Your honest, professional response is:

AnswerStrong answers: don't quote a number off the top of your head; explain the rate depends on which lender approves them and their credit; promise the finance office will shop several lenders and show real numbers; offer to show how the *payment math* works at a few rates so there are no surprises. The failure mode is blurting "you'll probably be around 4%" and creating a bait-and-switch when the real approval is higher.

Scoring Guide

  • 22–25 correct (≈88–100%): You own the broker model and the payment math. Move on to Chapter 23 (Leasing).
  • 18–21 (≈70–84%): Solid. Re-read §22.5 (the formula) and §22.6 (the Okafor financing) to firm up the math.
  • Below 18 (under 70%): Re-read the chapter, focusing on the threshold concept in §22.2 (broker / buy vs. sell / reserve) and re-working the §22.5 payment example by hand before proceeding.