Abusive Lending Practices Evident in Dealer-Financed Loans
As American consumers shop for cars, the lack of a transparent process and the various negotiations that occur can make for a confusing and complicated experience. Dealers often take advantage of unsuspecting buyers, according to an April 2011 study from the Center for Responsible Lending (CRL) titled, “Under the Hood: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses.”
Loans made through dealerships are prone to markups for which the interest rate might be higher than what the consumer would ordinarily be eligible for. Such markups are known as “dealer reserve” or “dealer participation” and are explained to the consumer as a way to pay the dealer for the time they spend putting together a financing package.
The markups consist of kickbacks paid to the dealer from a financial institution that eventually purchases the loan. The loan buyer sets a “buy rate,” or interest rate at which they will purchase the loan. The dealer, however, might be allowed to charge a higher rate to the consumer, the proceeds of which the dealer could keep or split with the lender. Consumers—possibly unaware of their own credit qualifications—are unaware of various loan options and simply accept what’s presented to them, rather than what’s in their best interests.
Data collected from 25 auto finance companies and other industry sources indicate the unfortunate consequences for some consumers who partake in such financing:
Such factors tip off dealers to consumers who could be easy prospects for higher rates. Although some financing might include markup control caps, it would not be uncommon for nearly $1,700 to be attached to a new car loan in the way of additional interest.
Auto dealers insist that increased repossessions are due to poor economic conditions. Repossession rates of dealer-financed loans, however, are twice those of other lenders.
The report also highlights other types of abuses foisted on auto-shopping consumers:
The deal becomes a “yo-yo” when the buyer is called back into the dealership and told that the sale cannot be made as agreed. At that point, the buyer is told to either return the car or accept financing at more expensive terms.
The potential for discriminatory lending exists. Research shows African-Americans and Latinos are more likely to be on the receiving end of markups than are whites in similar situations.
To resolve these issues, researchers suggest disconnecting dealer compensation from financing rates. They also say flat fees would be a better option for fairness and consumer understanding, ultimately leading to healthier loans.
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