The Center for Responsible Lending is out with its State of Lending report that demonstrates predatory lending practices are costing used car consumers billions of dollars a year in auto-loan interest rate markups.
Former Federal Deposit Insurance Corporation chair Sheila Bair authored State of Lending's foreword, notes that predatory lending harms the entire U.S. economy. She warns, "If abusive lending practices are not reformed, we again will all pay dearly." The report identifies regulatory and legislative actions that can halt today's predatory lending practices, prevent the rise of new abuses, and preserve access to fair, affordable credit. The center claims auto loan interest-rate markups cost consumers nearly $26 billion each year.
The Center for Responsible Lending is a nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL is affiliated with Self-Help, one of the nation's largest community development financial institutions.
As the report points out, "Purchasing a car is a complicated endeavor with several moving parts. The sales price, the value of a trade-in, and financing are all separate and negotiable transactions. Any of these elements can have a significant impact on the vehicle's overall cost.
"When financing a vehicle, consumers have the option to either secure financing directly from a lender, or finance the car at the dealership. If a dealership finances the car purchase, the dealer earns revenue on the sale of the car itself (known as the "front end" of the transaction) and also on the financing and the related sale of add-on products such as extended warranties (known as the "back end" of the transaction)."
"Access to credit is also a significant issue, and the risk of predatory lending is more acute for consumers with subprime credit scores. Consumers with high credit scores have multiple lenders in their communities offering to make loans to them. However, there are very few lenders with brick and mortar operations willing to make loans available to consumers with subprime credit scores," the report added.
Why does all of this matter? The report specifically mentions new cars but the language applies to used car buyers as well. It says, "Data show that customers acquiring financing outside the dealership are more likely to negotiate the price of a new [or used] car and the value of the trade-in vehicle. Consumers without the ability to negotiate, especially subprime customers with few, if any, other financing options, often are at the mercy of the dealer (Ed. Note - bold added for emphasis).
The Center for Responsible Lending found that consumers who indicated that they trusted their dealer gave them the best rate available paid between 1.9 and 2.1 percentage points more in their annual percentage rage, after controlling for credit risk, than those with a more skeptical outlook. The sad lesson here is you can't trust your used car dealer to give you the best interest rate.
Why is that? The simple fact is dealers make their money off financing and not so much off car sales. Let's look at the results from the Edmunds.com Auto Loan Calculator. A $10,000 loan financed over 48 months at 5% is going to cost the consumer $1054 in interest. Make that loan 7% and your interest is going to be $1494, or $440 difference. In this example, that's almost two extra car payments you're making because the dealer charged a higher interest rate.
That really reinforces the need to arrange your own financing before used car shopping. It's a point I've mentioned before in tips on buying used cars, "Know that you have the money to spend before you attempt to buy a used car. Go to your bank or credit union and take out a loan, or at least get pre-approved. Two important pieces of information are going to be handed to you: how much you can afford and what your interest rate is going to be."
What are the lessons that can be taken away from this report? When it comes to business, unless a used car dealer is your friend, then a used car dealer is not your friend. Do you want to put $440 in your own pocket or in the dealer's pocket?
Also, the most important lesson would be to always arrange your own financing whenever possible. It's going to put you in a better bargaining position when it comes time to arrange your next used car loan.