Americans will pay car dealers an extra $25.8 billion in interest over the lives of auto loans taken out in 2009, according to a new report by the Center for Responsible Lending. That translates to an additional $714 for every customer who received a loan through a car dealer.
Dealers extracted the extra payments by marking up the interest rates on loans. The average loan arranged by a dealer had an interest rate 2.47 percentage points higher than the rate for which the car buyer actually qualified. In most cases, consumers are never told they qualify for a lower rate.
“Our research concludes that interest rate markups from dealerships lead to more expensive loans and higher odds for default and repossession,” the study found.
The National Automobile Dealers Association defends markups, which it calls “dealer reserve” or “dealer participation,” as legitimate fees for performing the service of arranging credit. Critics of the practice also fail to understand how auto credit actually works, the association says.
Such criticism “assumes that retail car buyers can borrow funds at the same wholesale interest rates that are quoted to a dealer if those buyers would only go directly to lenders,” former NADA Chairman Jack Kain wrote in an press release. “But this is simply not the case.”
The dealers’ argument fails to explain why dealers charge some customers more for the service than others, according to the CRL’s report. Dealers take larger rate markups on loans for used vehicles, and on loans to people with lower credit scores, even though their fees for providing such loans don’t change the report found.
Also, markup rates vary significantly by state. The average dealer in Alaska takes only $54 per car in extra markups, where in California the average markup is $2,621, even though the cost of providing loans in both states is the same.
The higher the markup, the more likely the car buyer is to default on the loan and lose the car to repossession, the CRL found. Boosting the interest rate on a loan by 4.5 percentage points increases the likelihood of delinquency by 12%, the center found, and makes it 33% more likely that the buyer will have the car repossessed.
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Most consumers aren’t aware that any of this is happening, the report found. In a survey, 79% of consumers didn’t know that dealers can legally increase their rates without their consent. And 61% of car buyers don’t know the interest rate on their loan.
The report calls on Congress and federal regulators to stop or limit the practice of hidden rate increases. “(I)f rate markups from auto dealers disproportionately contribute to loss and delinquency, then the practice should be reined in,” the CRL writes.
Image: Harley Pebley, via Flickr