Dealer Financing Explained Without The Car Salesman Pitch

Buying a car sounds fun until you start shopping for it. At that point, you realize how much work goes into choosing the make, model and getting the loan for the new or used vehicle.

Once you have done your research on vehicles and have determined what you actually want, you need to shop around to find the best deal on financing unless you have tons of money in the bank.

If you know how to car shop, you know that you need to create a budget. And if you know what you can afford each month as a payment, then you know what you can spend. So, if you can save up a larger down payment, you can reduce your monthly payments. If this is your first car, you probably need to learn how to shop for a car loan.

Financing Your Loan

The time comes when you need to determine how best to finance it. Your choices probably include the bank, credit union, dealer financing or savings. Your first decision is either used car loans or new car loans. You need to know whether you will buy a new or used car.

Banks and Credit Unions

You can get a loan from your bank or credit union with a relatively strong credit score. We’re talking between 600 to 700. Banks like to loan to people who already have established good credit. Most credit score systems top out at 800 or 900. (Yes, there is more than one scoring system.) Regardless of whether it tops out at 800 or 900, realize that 600 to 700 translates to a really good score. The lowest score on any of the scales is 300.

Dealer Financing

So, what if your score drops below 600? You can still get a loan, but you will probably need to go with dealer financing. This option lets you borrow the money although you should be prepared for much higher annual percentage rates. Your interest payments can be remarkably higher with a dealer provided option.

Savings

It is totally wonderful if you happen to have thousands of dollars in the bank that it takes to purchase a car outright. Most people do not have that ability. However, if you do have this option, use it. You can very easily save yourself money by using your savings since you do not pay interest or finance charges on money that you own.

More on Dealer Financing

You already know what savings are and you probably have some familiarity with bank and/or credit union loans. On the other hand, dealer financing may just be a phrase you have heard on television commercials.

Dealer financing also referred to as special financing, refers to a type of loan called an indirect loan. This loan starts with the retailer which offers it directly to its customers. The retailer then sells the loan to a bank or another third-party financial institution. The financial institution typically purchases the loan at a discount. You still end up making payments of the principle and interest to the bank. payments from the borrower.

The auto dealership usually has an agreement set up with the bank already. If you read the fine print on the loan information at the dealership, you can determine which bank will ultimately own the loan.

Car purchase financing is probably the best-known example of dealer financing although you also see it in appliance dealerships and some major home improvement stores. You should really use it only as a last resort and here’s why.

Although the bank that ultimately buys the loan and the dealership work together to create the program, they do so with their profit in mind. The financial institution offers the dealership an interest rate that fits most consumers, also referred to as the buy rate. The dealer can then add to the interest rate it offers the customers.

Eek, Those Interest Rates

Why would they do that? It better covers their risk. Every entity involved in making loans is risk-averse. They add fees and interest rates to the loan amount to alleviate the risk. You pay them these extras upfront and on a monthly basis as risk rent.

Automotive dealerships want to sell cars. Most have an existing affiliation with an automotive manufacturer. They report their sales up the chain of command to the manufacturer. These dealer financing programs let the dealerships offer loans to people who would not typically qualify. That helps them sell cars to people who could not generally purchase them. These buyers might not normally qualify for bank financing due to a bad credit rating or other reasons.

The bank that buys the loan gets the interest rate they provided to the auto dealer. The auto dealer gets to keep the money from the mark-up on the interest rate. It becomes an extra profit for them.

Automotive dealers face no obligation to offer customers the best available interest rate.

The dealership gets to arbitrarily set higher rates or longer terms. The dealer can keep your loan rather than turn it over to the bank or other financial institution.

The Benefit to the Dealership

Not only can offering loans at the dealership mean that the auto retailer sells more cars, it means they sell them quicker. Rather than wait for a car buyer to arrange their own financing, the dealership can offer the financing so that the customer can purchase that day.

The Benefit to the Customer

Using dealer financing reduces the effort and time to obtain a loan. You can drive off of the lot with the car you like, typically on the same day you see it. It also provides an option for those with bad credit who cannot otherwise afford a bank loan.

Caveats to Dealer Financing

Not only might the interest rate cost more for a dealer loan, but there can also be other tradeoffs. Auto dealers extending financing to high-risk customers may install devices in the auto that disable it from starting if the customer misses payments. This also helps them repossess the vehicle if needed.

Other Terms Regarding Dealer Financing

Buy Here, Pay Here (BHPH): The terminology of dealer financing includes buy here, pay here which refers to automotive dealers that sell and finance vehicles.
In-House Financing: The term in-house financing refers to a seller financing program that provides customers a loan, so they can purchase its goods or services.
Floor Planning: Floor planning refers to a type of financing for large ticket items displayed in showrooms.
Subprime Auto Loan: A subprime auto loan refers to a loan type that features a high-interest rate. People with high credit scores qualify for prime rate loans while people with lower credit scores qualify for subprime loans.

The Truth About Car Dealerships

Car dealers may lead people to believe that they purchase their vehicles and that ties their money up in inventory. Not at all true. The auto dealers take out loans themselves to amass their inventory. The manufacturers provide the financing, the above-defined floorplan financing. You might think the dealer then loses money on interest, but that is not true either. The manufacturer reimburses dealers for their loan financing through a dealer holdback that typically equals one to three percent of the vehicle’s invoice price.

Here’s how it works. It might cost the auto dealer $350 a month to finance each vehicle. Let’s say a car takes two months to sell. The interest costs them $700. The car costs $20,000 though with a dealer holdback of three percent. That equals $600. If the auto dealer sells the vehicle in one month or less, they make a $250 profit just off of the holdback. The holdback remains the same regardless of how long the car sits on the lot. The interest accrues though.

That is another reason that car dealerships want to move vehicles off of their lots quickly. They did not sink lots of their own money into the inventory. Sp they did the same thing you will do to buy a car or truck. They took out a loan. Their loan costs them interest, too.

Let’s look at the math again. The dealer takes delivery of the same $20,000 car, but it sits on the lot for a few months. Let’s say it takes four months to sell it because there is a local depression going on and lots of folks lost their jobs. It does not sell until a new employer moves to town and hires a slew of new local people. With folks employed again, the cars start moving off of the lot again. Still, the dealer holdback of three percent stands. So does the manufacturer’s interest rate that comes to $350 a month interest. That means that interest cost them $1,400, but they recouped $600. If they are lucky, the manufacturer is also offering a manufacturer-to-dealer incentive of $250 per sale.

Automotive dealers make most of their money from the following:
– the extra money on your car loan interest,
– selling add-ons,
– trade-in vehicles.
The interest that dealers charge you over and above the bank’s interest rate can net them as much as $3,000.

When it comes to trade-ins, they low-ball the price they give you, then they turn around and sell it for a profit after a little detailing and regular maintenance. The dealer makes about $2,000 on the trade-in once it sells. Then there are the add-ons. These include accessories to the car, maintenance packages, gap insurance, an extended warranty, and much more. Between parts and service plus on-site maintenance, the dealer can add about $3,000 to their profit.

All of that together means the dealership makes about $10,000 off of the sale of a single car. Now, you see why they so badly want to move vehicles off of the lot quickly. The interest rate from their own loans from the manufacturer quickly eats up the profit potential. If a car sits on the lot for six months, it quickly eats into their profit. Six months cost them $2,100 in interest alone.

Getting Ready to Apply for an Auto Loan

Before you jump into the actual car shopping and auto loan applications, plan out your budget and get your credit ready. You typically know ahead of time when you will be car shopping. Start about six months before you want to buy your new or used car getting your credit ready.

While you have moved into credit checking mode, go to Creditry.com to learn how to manage your credit. This part applies whether you have great, so-so, bad, or no credit. Regardless of how you currently manage credit and money, you can always learn something new and improve. Creditry helps you keep on top of all your credit lines and loans. If you have not opened any credit lines yet, you are in luck because it lets you learn how to deftly manage your credit cards and loans.

Check your credit. You can do this for free by visiting the federal government provided free credit report website. Every twelve months you can obtain a copy of your credit report from each of the major credit bureaus. That means you will have three copies to compare and contrast.

You can apply for preapproval online or by visiting your local branch of the bank. You typically need to already know what type of vehicle you want, so the bank can determine if it is willing to assume the risk for you to afford it. When you get the loan directly from the bank or credit union, you will obtain a true interest rate with zero markup.

Budgeting for Your Vehicle

Hopefully, you already have a written budget established. If you do not, you can start now. Visit Budgetry.com to learn how to make a budget and get started. You will learn nifty stuff like how to calculate what you can actually afford to spend on each category.

Here’s an example. Did you know that you should only spend 30 percent or less of your total monthly income on housing? Yep. It is true. If you make $2,000 a month, you should pay $600 or less on rent or house payment.

You will also learn about budgeting savings into your monthly finances. You should be socking away at least 10 to 20 percent of your monthly income. Bank it. See all the nifty stuff about budgeting there is to learn? You have to continue to pay your bills, save and invest while you make your car payments. (Bet you wondered how that all tied together. Now you know.)

Remember, it’s not only about buying a car, but you also need to keep the car going later on. If you need to pay for any unexpected repairs, you need to have money saved up for that.
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Applying for Your Loan

Okay. After all of that, you can apply for your auto loan.

Start at Loanry.com. No matter what your credit score, you can use this website to determine which lending institutions would most likely give you a loan.

Loanry does not lend any money. It just works like a shopping mall for loans. Lots of lenders list themselves on the site. They include items like the minimum credit score they accept. This lets Loanry match you with the institutions that may extend you a loan. There is no promise of a loan. Loanry just might reduce the time it takes for you to find appropriate lenders.

Final Thoughts

Got your credit in order? Found a loan? Good job. Go vehicle shopping. You may buy whatever you can actually afford. Pick something that gets good gas mileage and has a high safety rating. You’ll save money on your auto insurance.

You probably already budgeted for your auto insurance, but in case you forgot it, such a bonus that you are reading this before you even car shop. Remember that you will either pay for six months of car insurance all at once or it will become a monthly expense. Your good credit score will help you qualify for a lower insurance rate. Your choice of car will help, too. The higher your credit score, the easier you will find everything.

Enjoy your new ride. Hopefully, you can get behind the wheel without having to resort to dealer financing.

Online Auto Loans Open Anywhere at Anytime

Here’s a recent headline from Forbes that kinda says it all:

Cars Are Costing More Than Ever To Purchase, Finance, And Own, Yet Consumers Remain Unfazed

On the one hand, here’s to capitalism and an American economy that allows you to purchase the vehicle you need (or at least want) through creative financing and good ol’ competitive lending. On the other…

Consumers are coping with rising prices and financing costs largely by extending their car-loan terms… Unfortunately, on average, for every 12 months a car loan is extended it will cost an owner nearly $1,000 in additional finance charges.

Ouch. And it doesn’t stop there.

Due to rising interest rates and other factors, the AAA says the average yearly cost of vehicle ownership has likewise risen to a record peak at $9,282, or $773.50 a month. Higher financing rates account for 40% of the rise in overall ownership expenses…

You get the idea. What does this mean for you as you consider your next vehicle?

I’m In Love With My Car

It’s not like most of us can simply do without. Sure, Americans in larger cities can get along quite contentedly with public transportation. And maybe a bicycle or Segway or something. For the rest of us, however, we pretty much have to have a car or truck. Otherwise, we can’t get to work, take the kids to soccer practice, and buy groceries. Just as important, our car is where we listen to our music or enjoy our podcasts. It’s where we think our own thoughts and process our day. It’s more than transportation – it’s a refuge.

So let’s assume you gotta have a vehicle. Statistics say they’re getting more expensive and people are paying more to finance them. How do you secure a car or truck that meets your logistical needs and maybe fulfills at least a few of your auto-related hopes and emotions, all without taking on unnecessary debt or getting yourself into credit trouble?

Let’s talk about logistics before you run out and start test-driving anything.

How Do Auto Loans Work?

It sounds like a silly question, but it’s something many people don’t adequately consider before they find themselves sitting in some salesperson’s office talking about whether or not they need to add on the upholstery protection package.

Where Can I Get A Loan?

Because of the cost of most automobiles, new or used, it’s traditional for buyers to finance vehicle purchases. This can be done in several different ways. Your local bank or credit union probably have published rates for automobile loans. You can even get pre-approved so that by the time you actually go car-shopping, you know how much you can afford to spend and approximately what sort of monthly payment you’d be committing to.

In the 21st century, there are numerous online auto lenders as well ready to compete for your business. Some even specialize in used car loans or auto loans for bad credit, for example. Auto loans online have the advantage of efficiency – you can usually go through the entire process without leaving your house, and approval times tend to be faster than with traditional lending institutions.

Interest rates for online auto loans are very competitive since many online lenders are designed to be efficient and operate in very competitive conditions. You won’t be sitting across a desk trying to persuade a guy in a suit that you’re worthy; online lenders will be working to earn your business and keep you happy. That’s how they succeed. We’ll talk more about how to find the most reputable and reliable online lenders in a moment.

How Does The Loan Work?

Traditional auto loans (including online auto loans) are term loans at fixed interest rates. That means that once you’re approved, you’ll be presented with a fixed number of monthly payments at an unchanging interest rate until the vehicle is paid in full. The advantage to this is that there are no surprises – your payments come due at the same time every month and stay the same throughout the life of the loan.

That doesn’t mean there are no variations. Or that it’s impossible to make adjustments if your circumstances change. But unless otherwise specified, auto loans are pretty straightforward.  Be aware, however, that any number of things can influence just how much that monthly payment might be. You may also encounter some very tempting alternative forms of financing. In such cases, it’s all about the details. You might save thousands, or spend thousands more in unexpected fees or additional interest. Always pay attention to the specifics, and don’t hesitate to ask questions!

How To Get An Auto Loan

On the one hand, as we discussed above, most auto loans are fairly straightforward in terms of how they’re structured. On the other, there are several considerations you should be aware of before you get too far in the car-buying process. So let’s see how can you get an auto loan.

The first – and it’s a big one – is the question of where you want to finance. There are three basic options: a local bank or credit union, one of the many online lenders available in the 21st century, or the dealership where you purchase your vehicle. For either of the first two, it’s usually wisest to talk about your options before you shop for a specific vehicle. Most local banks and credit unions, as well as lenders specializing in online auto loans, have procedures by which they can pre-approve you for a specific amount. That way, by the time you’re actually shopping, you know exactly how much you can afford and what you’ll be paying monthly if you decide to commit.

You’ll want to be prepared with documentation of things like your income over the past year, employment information, and other basics. While it may not be essential at this stage, you should at least be thinking about whether or not you’re likely to trade in your existing vehicle or make a substantial down payment on your new purchase. Finally, you should have a pretty good idea whether you’ll be focusing on new or used vehicles as you shop.

Online Auto Loans

Exploring your online options can be a bit daunting without guidance. We do many things here at Loanry, but one of the biggest is connecting borrowers with reputable online lenders. Don’t worry, we’re not going to charge you for anything, and we don’t loan money ourselves. Instead, we gather some basic information about who you are and what you’re looking for. We can help you get your own copy of your credit scores or even your full credit report absolutely free. Our online tools, such as our online loan calculator, can even help you play with the numbers ahead of time so you feel more confident going in.

There are several advantages to online auto loans. The most obvious is that the entire process takes place online. You can do it any time of day or night from wherever you happen to be. Who would have thought only a generation ago that you could receive multiple offers from lenders competing for your business while sitting in your underwear in the middle of the night eating Corn Nuts?

That’s not required or anything, but it does highlight the convenience of online auto loans. Those Corn Nuts probably aren’t doing your keyboard any favors, though.

If you have a decent credit history, online auto loans tend to offer very competitive interest rates and other terms. You may have the pre-approval or the money in your account as early as the next day

What Role Does My Credit Play When I Want an Online Auto Loan?

The short answer is “a big one.”

Your three-digit credit score and your credit history are major factors in whether or not lenders are willing to extend you the loan you’re seeking for the car or truck you want. Now for those of you who aren’t familiar with credit scores. There are two common forms of this magical number – the FICO and the VantageScore. While computed slightly differently, each results in a number between 300 – 850. This acts as a “snapshot” of your overall creditworthiness for lenders. Each one considers your payment history, your current debt or debt-to-credit ratio. And overall reliability when it comes to various forms of credit extended to you in the past.

Auto lenders, including those specializing in online auto loans, sometimes modify these numbers to give extra weight to your auto loan history specifically. After all, they’re primarily concerned with whether or not you’re likely to pay for the car or truck you’re trying to buy. Not your track record with your landlord, the credit card companies, or your past due medical bills. It’s not that those things don’t matter. But sometimes your payment history with the same sort of loan they’re considering extending to you matters more.

The advantage (and arguably the major limitation) of a three-digit credit score is that it’s straightforward and easy to compare to whatever internal charts or tables a lender might use to determine what sort of interest rate to offer you, or whether to offer you a loan at all. Some lenders, particularly those offering online auto loans, want to look a bit deeper. They’re looking for reasons to say yes, not reasons to turn you down. In that case, they’ll probably look at your full credit report.

Your credit report has a detailed history of every loan you’ve ever taken out and how you did repaying them. It will show your employment history, where you’ve lived, and all sorts of other details about you. If you had a rough patch several years ago, but have been regularly employed and paying your bills on time more recently, that will be easier to establish with a credit report than simply looking at a credit score. If you’d like to know more about the role of your credit in financing a vehicle, my colleague Julia Peoples elaborated about it recently in a piece well-worth checking out.

Online Auto Loans With Bad Credit

A rocky credit history will make any loan more difficult, but it doesn’t necessarily disqualify you from getting the car you want. Many online lenders specialize in loans for people with bad credit, or with very little credit history at all. Be aware you will probably be looking at a few fees upfront and possibly stiffer penalties for any late payments. Interest rates will be higher as well because the risk to the lender is greater. Make sure you’re OK with the terms and that you can realistically make your monthly payments for the life of the loan before committing, even if you really really really want this vehicle!

If you do choose to move forward with the loan, be aware that every payment you make – or don’t – impacts your credit rating and overall credit history. Online auto loans for bad credit can be an opportunity to not only drive away with the car or truck you’ve been wanting, but to rebuild your credit and establish a positive history with a lender you may wish to utilize again someday.

There are other options to consider if you have less-than-perfect credit. You can use these in conjunction with whatever loan you manage to negotiate or try one or all of them separately.

The first option is a co-signer. This would be someone with a strong credit history who trusts you enough to put their credit rating on the line to help you out. If you make your payments as scheduled, your credit record improves without any change to theirs. If you don’t, their credit record is damaged and they may eventually be expected to pay what you’ve promised. That makes this a big deal and not something to be taken lightly. Money matters, but so do relationships, yes?

The second option is to make a substantial down payment. There’s a difference between having a shaky credit history and being completely without resources. Saving money isn’t always easy, but even a few thousand dollars down can make a huge difference in your monthly payments, interest rates, and even the willingness of lenders to take a chance on you. This tends to be true of traditional lenders as well as online auto loans.

A third option is to challenge any inaccuracies on your credit report, or to spend six months or a year working on your credit rating before you apply for a loan. This can be tedious, but even a few minor errors on a credit report can impact how a potential lender views your potential. You should avoid anyone promising to work miracles with your credit rating in a short time – especially if they want to charge you. There’s nothing they can do that you can’t do yourself for free. But one nice thing about bad credit history is that there are limits to how far back lenders look. Even a few small moves forward can make a big difference when it’s time to actually apply for a loan.

Finally, you can consider a less-expensive vehicle. Maybe the car or truck you really want is new or relatively new. But the dealer has an older option with similar features and a decent used vehicle warranty. It may be easier to borrow a much lower amount. And timely repayment improves your credit history just as reliably as paying twice as much would do. It’s not always easy to compromise. But try to look at the big picture and the long game as well as the immediate situation.

Trade-Ins, Down Payments, and New vs. Used

Trade-ins are a crapshoot with car dealers. It’s difficult to know how much they’re really giving you, but you can at least go into the process with a blue book value for your existing car and do a little research about the most likely vehicles you’d like to buy and what they’re selling for in your area. It can be tedious, but it can also save you literally thousands of dollars over the life of the loan – and that ain’t nothing.

Down payments are a bit more straightforward. If you can reasonably afford to pay even a few thousand dollars down on your new purchase, it can shave a substantial amount off of your monthly payments. It might also allow you to shorten the life of the loan, which saves you even more on interest over the life of the loan. What might seem like a small chunk each month adds up quickly in three or four years.

Finally, buying a new car vs. purchasing used is a major decision. New vehicles are, of course, new – which certainly has appeal. The smell alone may feel worth the extra money and extended life of the loan! Then again, you can buy “new car smell” in a spray and shave off up to half the cost of the vehicle… so there’s that. Generally, you’ll find financing a new vehicle to be a bit easier. The car or truck itself acts as natural collateral for the loan. And dealers are generally anxious to move new cars and trucks off the lot more than they are their inventory of used vehicles. Used cars, of course, cost considerably less to begin with. Some dealers offer pretty solid warranties on their previously owned inventory. And insurance will be much less than it will for a new vehicle.

It’s all up to you, but these are decisions that are much easier to think about before you’re standing on the lot, staring down the row of shiny new toys. But I digress – we were talking about where to look for the best loans…

Dealership Financing

Dealer financing is in many ways similar to what you’ll find at your local bank or credit union or with most online auto loans. But it can present a few wrinkles which may be to your advantage or may not. One of the biggest factors is that if you’re sitting at the dealership talking about financing, you’ve probably already selected a car or truck you’d really like to drive home. Needless to say, that can change the dynamics of the financing discussion considerably. We want you to have the vehicle of your choice, but that shouldn’t lead you to skim through details that might end up costing you more than you realize over the life of the loan.

Most major dealerships have their own financing departments. This can be advantageous to you. Because it’s not unheard of for dealers in need of moving product off the lot to cut some great deals on price. Knowing they’ll make up some of the difference through their financing. You’ll also no doubt hear of special financing offers throughout the year – no money down, zero percent interest, etc. These also tend to come when dealers are in need of moving vehicles. Finally, dealership financing is available whenever the dealership is open – nights, weekends, whatever. When you’re ready to buy, they’re ready to finance you. (Then again, that’s true of online auto loans as well – but still…)

On the flip side, dealerships know that in the 21st century, they can’t make the sorts of margins they used to on each car or truck they sell. The internet and the proliferation of information available to consumers means they have to become increasingly creative about where they can squeeze out profits. If you’ve bought a new car in the past, you know how quickly the “oh-by-the-ways” add up after you think the price is settled.

“Oh, by the way – there’s a fee for driving the car off the lot. Standard stuff, don’t worry about it.”

“Oh, by the way – you’ll want the extended warranty on parts and transmission. Pretty typical, I’ll just add that on.”

“Oh, by the way – you should get this extra thing here everyone does. It’s on line 72 there. Can you initial next to that?”

“Oh, by the way – local taxes and fees. And tag and wheel-cleaning surcharge. And the cost of all these spotlights and balloons… just sign right there at the bottom…”

it’s not unheard of for dealers to slip in extra fees or charges to the financing paperwork. They know you’re anxious to wrap it up at that point. And unlikely to argue over a few hundred dollars here or a few monthly add-ons there. And maybe you won’t. But don’t let your desire to get on the road persuade you to smile and nod and sign on the dotted line. You haven’t committed yet, and if you don’t like what they’re offering, you can still walk away.

Honestly, more of us should sometimes.

Finally, don’t get fixated on the monthly payment being offered. It matters, absolutely – it’s very important that you be able to confidently make that payment every month on time. But look at the cost over the life of the loan as well. Manageable payments for an extended number of months still add up to a major investment. Don’t sign until all of the numbers make sense to you and your questions are answered.

Conclusion

It may seem a bit overwhelming, considering everything at once, but you’re going to do fine. The key is to keep your information organized and not let yourself be rushed into anything you’re not comfortable doing. Sit down with several lenders and explore online auto loans as quickly or as methodically as you choose. Don’t let dealers persuade you that you have to leave with a car or truck the first time you visit. Or the second, or the third. Buy when you’re ready to buy.

We can’t tell you which vehicle is best for you. And we’re not going to tell you what offers to accept. Or whether to accept any of them at all. Our expertise is connecting buyers with online auto lenders who then compete to offer you online auto loans. This flips the traditional dynamic associated with getting an auto loan or any other kind of financing. There’s no reason you should go from lender to lender begging for credit. You’re the customer, whatever your credit rating or credit past. They should be working for your business, not the other way around.

We’d like to think it doesn’t stop with a car loan or any other single transaction. At OfferEdge, we’d like to become part of your overall financial health and progress. Whether it’s loans, investments, taxes, budgeting, or anything else related to making your money work for you instead of you always working for your money, let us show you what we can do. Maybe it’s a little idealistic, but we believe things can be better than this.

In the meantime, let’s see what we can do about hooking you up with those lenders. Just between you and me, I’d pass on the upholstery protection package.