Here’s some good news for car buyers. Our money watchdog ASIC has cracked down on so-called “flex” commissions paid to car dealers, putting motorists in a better position to secure competitive finance at the car yard.
Flex commissions are paid by lenders to car finance brokers - typically car dealers. According to ASIC, they’re quite common in car finance but not generally found in other markets so it’s understandable that car buyers may not be aware of the practice.
The problem with flex commissions is that they allow dealers to arrange car loans at a higher interest rate than the lender’s lowest available rate.
As a guide, ASIC found a car dealer can decide whether a customer will be charged an interest rate of 7% - or one of 14% - regardless of the buyer’s credit history. The dealer is then paid a commission based on the difference between the lender’s base rate and the interest rate sold to the consumer - the 'flex amount'.
The higher the rate, the larger the commission for the dealer. But for car buyers, this system can mean paying thousands of dollars more in interest charges over the life of the car loan.
The ban on flex commissions makes lenders more responsible for determining the rate that applies to a particular car loan. The dealer cannot suggest a different rate that earns them more commissions. Car yards will even have some capacity to discount the interest rate, presumably to secure a sale, potentially leading to lower costs for car buyers.
The ban on flex commissions highlights the importance of shopping around for finance before you hit the car yards.
It’s very easy to focus on how your next set of wheels will look and feel without giving thought to the true cost of the car after allowing for finance charges. Yet it’s a cost that can significantly add to the total amount paid for a vehicle.
By way of example, on a car costing $25,000, using a five-year loan with a rate of 12%, which is the current rate among some of our bigger banks, you can expect to pay total interest of $8,366. However, a quick look at comparison sites like Finder shows a reasonable selection of car loans are available costing 8% (in some cases less), and at that price, a five-year loan on the same car would cut your interest bill to $5,414 – a saving of $2,952.
Opting for the shortest financing term your budget can handle is another way to trim interest charges.
If you’re new to the car buying experience, take a look at ASIC's MoneySmart Cars app. It’s free to download, and it can help you avoid common traps and identify hidden costs when you hit the car yards.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.
More cash on hand often comes down to a bigger salary, but sometimes it also comes down to money smarts.