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Don’t let auto dealership markups take you for a ride: CFPB warns dealers to comply with fair lending law

CFPB warns dealers to comply with fair lending law

Charlene Crowell

The Consumer Financial Protection Bureau (CFPB) recently issued a warning to banks, finance companies and credit unions that these institutions will be held accountable for discrimination in auto lending. In announcing its intention to hold auto lenders accountable for illegal, discriminatory markups, CFPB also published a bulletin detailing ways lenders should incorporate practices designed to honor fair lending laws.

At the crux of CFPB’s concern is a practice known as “dealer reserve” or “dealer participation.” Both are synonyms for a markup on financing cost that is typically hidden from the consumer. These fees add more cost to the consumer and more profit for the dealer. The fact that consumers are unaware of the additional interest makes it difficult to negotiate prices fairly and with full information.

For consumers, the issuance of the warning is an important action. Rather than waiting for discrimination to occur, CFPB’s oversight intends to stop biased pricing before it happens. It should also be welcome news for consumers with problematic credit. The potential buyers at the greatest risk are those who lack other financing options. Adding vehicle financing to an auto purchase enables dealers to raise the loan’s interest rate and keep some or all of the difference as commission. As a result, these consumers typically receive the worst deals.

Keep in mind that interest rate markups occur at the dealers’ discretion and many times have no relation to actual credit risk. Financial exploitation is a form of discrimination.

The Dodd-Frank Financial Reform Act gave CFPB the authority to supervise more than 150 of the nation’s largest financial institutions, including those with $10 billion in assets. This supervision applies whether the lender is a bank, a credit union or an affiliate. In 2012, 15.7 million auto loans contributed to $783 billion in consumer debt. Car notes are also the third largest source of household debts, after mortgages and student loans.

Discriminatory actions will persist in the absence of strict enforcement. Just as HUD oversees the Fair Housing Act, communities of color are legally protected from discriminatory practices through the Equal Credit Opportunity Act (ECOA). The ECOA makes it illegal for a creditor to discriminate in any aspect of a credit transaction on the baseis of race, color, religion, national origin, gender, marital status or age.

Despite these laws, some lenders continue to ignore the spirit, if not the letter of the law. Research by the Center for Responsible Lending (CRL) released in 2011 found that discriminatory auto lending pricing was evident. A series of class action lawsuits challenged the practice of giving interest rate markups more frequently and to a greater degree to African Americans and Latinos than to their similarly situated white counterparts.

Through an analysis of 25 auto finance companies that together accounted for 1.7 million vehicle finance accounts by the end of 2009, CRL discovered that although vehicle sales declined by 20 percent from 2007 to 2009, the amount consumers paid in interest rate markups over the lives of their loans during this same period grew 24 percent from $20.8 billion to about $25.8 billion. Beyond higher markups, poor credit ratings can lock consumers into finance rates so high that repossessions become the norm rather than the exception.

Now, thanks to the CFPB’s watchdog role, if or when financial violations occur dealers are assured that swift enforcement will be taken.

It just makes sense for consumers to shop for the best auto lending rates, just as consumers are encouraged to shop for the best mortgage rate for a home. Most importantly, consumers should be keenly aware that the convenience of buying and financing a vehicle from a dealer will likely be more costly than if financing and sales were handled separately. 

Shopping for financing first enables consumers to learn their credit scores, current competitive rates on loans and how much of a loan is affordable in comparison to their other expenses and debts. Deciding up front the household comfort zone for new debt and how long it should last would lead to loans that are better managed and affordable.

Just as the historic Brown v. Board of Education decision held that in education separate was inherently unequal, the same can be said of lending: let it be equal.

Charlene Crowell is a communications manager with the Center for Responsible Lending.