Auto loans are a part of life for the 80% of Americans who finance their automobile purchases. Buying and borrowing smart are key to your financial prosperity.
If you owe more on your car than you could sell it for, your car is upside-down, which is a fairly common situation. Understanding car depreciation, interest and fee costs are important when you purchase a vehicle.
If you’re looking for a new or used car and you’re going to use dealer-arranged financing, consumer groups have a message for you: Watch out. You may pay more for that loan than necessary, especially if you’re black or Hispanic.
This week, the Consumer Federation of America (CFA) released a report titled, “The Hidden Markup of Auto Loans.” In the report, CFA attacks a common practice in the auto-lending field in which dealers mark up interest rates on car loans.
These finance charges typically add at least $1,000 to the cost of an auto loan, and are costing consumers as much as $1 billion annually, said Stephen Brobeck, executive director of CFA, a nonprofit association of 300 consumer groups.
The higher-priced loans affect about one in four consumers who get their car financing through dealers, the report concludes.
In addition, the report says, the subjective nature of dealer markups has led to discrimination against African-Americans and Hispanics.
“Finance markup charges have amounted to a costly skin tax, burdening African-Americans with even higher costs on one of the largest purchases they are likely to make in their lifetimes,” Jesse Jackson, president and founder of the Rainbow/PUSH Coalition, said in a release.
What’s also aggravating about this practice is that blacks and Latinos with good credit records are paying more for dealer-arranged loans, said Brenda Y. Muniz, policy analyst for banking and financial services for the National Council of La Raza.
“I don’t think people know that this practice exists,” Muniz said. “And those who know it exists – regulators and legislators – should be doing something to curb this practice.”
You’re darn right they should. Auto loan markups are a devious way for car dealers to earn additional profit. And I make no apologies for using the word “devious,” because for the most part the markups are kept secret. Here’s how this practice plays out:
A consumer decides to let the dealership handle the financing on a car. The dealer contacts a lender. The lender, taking into account the potential buyer’s credit history and other information, such as the type of vehicle being purchased and length of the loan, approves the loan application for a certain annual percentage rate known as the “buy rate.”
Unbeknownst to many consumers, the dealership may decide to increase the buy rate for no other reason than it can. It’s a legal way to pick people’s pockets. So, for example, a person’s buy rate might be five percent, but the dealer might tell a consumer she’s been approved for a 10 percent loan.
Let me break it down to you this way. Suppose the car you want to buy costs $20,000. Interest charges on a 48-month loan at five percent would come to about $2,100. But kick the rate up to 10 percent and the interest charges jump to $4,300.
Recently, some auto lenders such as Ford Motor Credit Co. and General Motors Acceptance Corp. have capped the markups that dealers can charge to three percent.
I still can’t see how that’s reasonable. The auto loans are already priced to include a profit for the lender, so why should car purchasers pay one penny more?
Well, the industry argues, auto dealers should be paid for helping arrange financing for their customers.
“The rate provided by finance companies to dealers is a wholesale rate,” the National Automobile Dealers Association (NADA) said in a statement. “So, it is not accurate to say that car buyers pay extra for dealer-assisted financing since the wholesale rate is not available to the public. It’s the same as the difference between what McDonald’s pays for a hamburger and what we pay for it. The McDonald’s markup is undisclosed.”
Yeah, but we don’t have to sign a contract and take out a loan to buy a burger. There’s a lot more money at stake, and that should mean more disclosure.
But I do agree with NADA that dealers are providing a service when they act as finance middlemen.
How much should they get for their work?
“A fee of $100 to $200 is more than enough compensation for arranging financing,” Brobeck of CFA said. “And we want the fee disclosed.”
Brobeck and Muniz said the report is a precursor to a massive consumer education campaign to get the word out about auto finance markups.
“Our mission is to let every consumer know about this practice and what they can do to protect themselves and secondly, to persuade the auto finance companies and dealers to eliminate the markup,” Brobeck said.
Of course, ending markups in the industry as a whole won’t happen tomorrow. So if you are in the market for a car, go shopping for a loan too.
Before you go near a dealership, visit your bank or credit union and find out what interest rate you would qualify for given the car you want to buy. Get a pre-approved offer if you can (that’s what I always do). Even if you like the convenience of using dealer-arranged financing, at least get another rate quote so you’ll know if you are being marked up at the dealership. Do this even if you know you’ve got a checkered credit history.
Don’t be so desperate for a car that you put yourself in the position of being taken advantage of.