I am a complete tractor newbie. Just bought a 25 acre place that came with an old (not working) Farmall and a lot of work to do...and deciding what I need/want for a tractor. Love reading here and seeing the collective knowledge and experience.
That said I am a little bit familiar with how money works, forgive me in advance for the long post, complicated subject. If you want a very simple explanation of “interest” than just remember this “interest is the RENT you pay to use somebody else’s money”. When you finance something you are ALWAYS using somebody else’s money.
More complicated is below.
Yes there is a "cost" and a "price" for anything that is sold, including tractors. That tractor "cost" a certain amount to make, and some more to ship, and some again to make those cool advertising videos. Then there is the "price": what has to be paid that cover all of that "cost" plus enough for the dealer to stay in business and make a profit. For simplicity think of price = cost plus the profit margin. That is the easy part. If everybody paid cash and there was never any credit then everything would work just like that. (Skipping over "barter" and commission considerations which seek to increase the margin so the PROFIT gets bigger after costs are covered) Grocery stores work on incredibly tiny margins and focus on continuous and large turn over. As you sell fewer and fewer items you have to get bigger and bigger margins on each individual sale. So back to tractors…and I am going to make up some easy numbers here…
lets say a dealer buys 20 tractors whole sale from the manufacturer at $20,000 each. He has spent 400,000 on tractors. If he just put that $400,000 in the bank instead of buying tractors he would get an interest return on that money, lets say 2.0% a year. At the very minimum for any of this to worth the dealer’s time then he has to make AT LEAST $8000. Now add whatever expenses the dealer has to run his business to that, say $92,000 a year and we have a rough $500,000 which spread over 20 tractors = $25,000. That is the PRICE of that tractor and incidentally indicates that he needs a 25% profit margin on each tractor in order stay in business and take home 400 dollars from each sale.
So cash sales = each sale means the dealer can buy another tractor to sell, pay employees, and bring that above mentioned 400 dollars home to momma. And the business moves along.
Finance = complicated. First you have to consider that you are now using (renting) his money to pay for that tractor. Second you have to consider that in order to get another tractor in the shop to sell the dealer needs to have $20,000. Finally we already know that the dealer can get 2% interest if he just put the money in the bank (So you KNOW that he isn’t going to just let you use his money for anything less than 2%)
So in order to even consider letting somebody finance a tractor with his money the dealer needs to address those three things you just considered. That means he has to add that to the “COST” of the tractor he sells you. Start by adding the 2%. Now add some more to that because you are more of a risk then letting the bank use it, add another 2%. Now add that he still needs to pay to run his shop and that cost money every month, add another 2%. He also needs to start getting enough money together to so he can buy another tractor long before you pay off the first one … or he will soon have no tractors to sell, add another 2%. Don’t forget inflation add another 2%. So the new COST is 10% higher than the original 20,000 = 22,000. Now add that profit margin of 25% on to that cost and your PRICE is 27500…which he will let you pay in 60 monthly installments at “no additional” interest charge.
Then for every place in the above explaination that I had “dealer” switch it for “the manufacturer” and the put the dealer in the “buyer” position and run the process through again. Then put the “raw material supplier” in the “manufacturer” position and the manufacturer in the “buyer” position…that is the cost of credit.
That is all a very simplified version! Imagine a salesman trying to explain inflation, the risk premium, the risk free rate of return (that original 2%), etc…Much easier to wrap that up in “COST” and then tell you the “PRICE”. And it sounds a lot sweeter if you hear “0% additional interest”.
Yes ALL car dealers do that (sometimes the manufacture or a government will absorb the interest cost). Mortgages do the same (paying points = the same thing, paying intrest or buying interest. In fact in any finance situation this happens.
