It’s no secret that car dealers rely on the lending community — banks and-auto industry-owned finance companies — to help close sales. What’s less well-known is how they benefit from these relationships.
Many lenders allow the auto dealerships with which they partner to negotiate and document loans on their behalf. Some even let them increase the base interest rates, which can substantially enhance the dealer’s already profitable sale. Here’s how.
Suppose the going rate for a three-year, $10,000 auto loan to a consumer with a middle-of-the-road credit score is 5 %. In that case, the borrower would pay $299.71 per month for 36 months. Now suppose the dealership were to mark-up that 5% rate to 7%. The borrower would end up paying $308.77 a month for the same loan.
That’s $326.20 of extra interest over the life of the loan, from which the dealer would be paid a $302.36 commission upfront — roughly 3% of the original loan amount. If the loan term is five years, the consumer would pay an additional $557.86 in interest from which the dealer is paid $492.79 — approximately 5% of the loan value.
(A quick and dirty way to approximate this calculation is to divide the loan term in half, and multiply that value by the difference between the two rates. For example, a five-year loan term divided by two equals 2.5 years, which multiplied by the 2 percentage-point difference between the two rates, would yield 5% of extra profit for the dealership.)
While there’s no prohibition against marking up an interest rate (as long as what’s ultimately charged isn’t usurious), this kind of latitude can lead to abusive lending practices; hence the regulatory attention it’s attracting.
Earlier this year, the Consumer Financial Protection Bureau issued a bulletin in which it put lenders on notice that they should expect to be held accountable for any discriminatory lending practices by the auto dealerships they support. For example, the Wall Street Journal recently highlighted a case involving a dealer, working with Bank of America, that routinely charged higher auto loan rates to women. (Bank of America sent a letter to the dealer, ordering it to comply with fair lending laws.)
As you might expect, the financial-services and auto industries are bristling at the notion of this added regulatory burden. Who can blame them? After all, hundreds of millions of dollars’ worth of dealer profits are at stake, not to mention the potential risk of class-action lawsuits.
Setting aside for a moment the auto industry’s worry about an end to what’s been a pretty sweet deal with a delightfully long run, should this extra measure of scrutiny really trouble lenders that, in the end, are the ones putting up the money? I don’t think so, for a very simple reason: the higher the interest rate, the greater the risk of default.
While $10, $20 or $30 per month may not sound like much to some people, to the most vulnerable segment of the population — the working class and working poor who’ve reportedly been the targets of disparate credit treatment — a higher rate can mean the difference between a loan that’s paid in full and one that ends up in bankruptcy court.
Avoiding the Higher Rate
In the meantime, what can consumers do to protect themselves? Know the options.
There are plenty of online sites that rack and stack auto financing alternatives — locally, regionally and nationally. (Ed. Note: Credit.com is in fact one of them.) You don’t have to apply for any of these loans. Just be aware of the pricing range so that you can fact check the terrific deal the sales rep says he is bending over backwards to make.
And should you determine that you’re one of the many consumers who’ve been disparately treated by a dealer (and/or the lender), be sure to file a complaint with the Consumer Financial Protection Bureau.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.