As 2013 approaches, a new law takes effect in California that strongly regulates how Buy Here Pay Here dealers can operate, including restrictions on how quickly used cars can be repossessed and how loans can be repaid. Here's a primer on Buy Here Pay Here dealers and what you might expect.
Buy Here Pay Here dealers are just what their names suggest. Consumers go into the dealership, often because they have subprime credit that prevents them from getting a loan anywhere else, and then make arrangements to pay their loans directly to the dealer, at the dealership, usually on a weekly basis.
As has been reported here before, Buy Here Pay Here dealers are really in the business of selling loans and not selling used cars. It's the loans that bring them in the huge profits, with interest rates typically around 25%.
The Center for Responsible Lending is out with a comprehensive report on Buy Here Pay Here dealerships as part of a larger report on consumer loans. As it explains in its report, Buy Here Pay Here dealers specialize in selling cars to those with blemished credit or no credit history. As of 2nd quarter 2012, 88.3% of its customers are considered subprime.
The financing at BHPH dealerships is fairly expensive, and the vehicles they sell are older, high-mileage cars sold at a substantial price markup, according to the Center for Reponsible Lending. It says many BHPH dealers do business as small independent operations. However, there are larger chains like JD Byrider and DriveTime that have a multi-state presence. A growing percentage (4.3%) of traditional franchise dealers also have a BHPH operation within their larger company. (They announce that in their ads by saying, "No customer turned away.")
As the center observes in its report, "Most BHPH dealers do not post prices on the cars on the lot. The dealer first assesses what kind of weekly or biweekly payment the consumer can be expected to pay. Then the consumer is told which car or cars are available to them and the price is set." This is a disaster for most used car buyers because it allows the dealer to control the transaction from start to finish. Read my article on how to set a used car value to make sure you're paying a fair price for the vehicle that is not based on your ability to make monthly payments.
BHPH dealers also routinely use devices that prevent the engine from starting or a device that tracks the car's whereabouts using GPS when the consumer misses a payment. These devices increase the dealer's ability to repossess cars from delinquent borrowers. Currently, 7 out of 10 BHPH dealers indicate that they install these devices on every vehicle they sell, according to the center.
Among different credit tiers, according to the Center for Responsible Lending, "deep subprime has the slowest return of available lenders competing for business, which keeps rate pricing relatively high. Larger BHPH chains like JD Byrider and Drive Time report an average credit score of 550 and below for their customers."
Nationwide, consumers who purchased cars in 2009 paid $25.8 billion in additional interest due to the dealer's markup of the interest rate. The average rate markup was 2.91 percentage points for used cars.
Data also show that rate markups are significantly correlated with used car subprime lenders and with higher odds of default and repossession. For example, the center says, borrowers with a loan from a subprime finance company that includes an interest rate markup are 33% more likely to lose their cars to repossession."
The troubling thing is these interest rate markups often happen after a consumer has signed an agreement, traded in an older used vehicle, and then handed over a down payment. The dealer then informs the consumer the initial rate was rejected and a newer, of course higher, rate has to be charged. The astounding thing is the consumer signs a loan agreement allowing this to happen. As the center reports, "And, consumers are largely unaware of this practice, as 79% of consumers surveyed in North Carolina were not aware dealers could mark up rates without their consent."
These types of loans are called yo-yo scams. "Yo-yo scams are possible because of the pervasive "spot delivery" practice where dealers allow consumers to take possession of the car even when the financing is not final," the center said in its report. Then, if the dealer cannot meet the lender's terms to purchase the loan, or if the dealer decides that the offer to purchase the loan is insufficient, the dealer asserts the ability to cancel the deal and force the consumer to sign a new loan contract."
The center's research has shown that low-income and poor-credit borrowers are much more subject to yo-yo sales. Consumers involved in yo-yo scams receive interest rates 5 percentage points higher than those that are not . Those caught in a yo-yo have a difficult time reclaiming their down payment or trade-in, and end up settling for a more expensive deal than the original one they agreed to.