Buying a car is one of the largest purchases a person makes and one of the biggest loans a person takes. Today, consumers and lenders face a confusing and fragmented system when it comes to the regulation and protections offered around auto-lending.
Under the current system, if a consumer receives a loan directly from a bank or credit union, the transaction is governed by rules established by the Consumer Financial Protection Bureau (CFPB) and enforced by the bureau—and possibly the primary regulator of that institution as well. However, if a consumer is offered the loan from their auto dealership, whereby the dealership finance officer is essentially acting as a broker in what’s known as in-direct auto lending, then an entirely different set of rules and enforcements apply.
This bifurcation of consumer protection runs counter to the goals of the Dodd-Frank Act, which were to create a level playing field for financial products and regulation regardless of the type of institution that provides them. The Treasury Department articulated this need when they first proposed a consumer agency to create “a level playing field and higher standards for providers of consumer financial products and services, whether or not they are part of a bank.”1 Auto dealers avoided having to play by these rules when lawmakers negotiated a carve-out as part of the political process of drafting the legislation in 2010.2
A key reason why there is a strong need for a level playing field is that consumers are often not fully aware of what the parameters of negotiation are for an auto loan. While price negotiation is commonplace in many countries and cultures (I once spent 3 hours negotiating the price of a taxi ride in Egypt), it is exceedingly rare in the U.S. Almost everyone knows that when you walk into a car dealership you are supposed to barter over the price of the car. What most people do not realize is that if you are obtaining an auto loan from a car dealership, you can and should negotiate over the interest rate as well.3 Indeed, it is as much a part of the overall deal as the sticker price of the car where haggling is expected.
Don’t take my word for that. Consider that the Federal Trade Commission states: “The APR that you negotiate with the dealer usually is higher than the wholesale rate, because it includes an amount that compensates the dealer for handling the financing. Negotiation can take place before or after the dealership accepts and processes your credit application. Try to negotiate the lowest APR with the dealer, just as you would negotiate the best price for the vehicle.”4 Of course, how many people consult the FTC’s website before buying a car? To assume that this knowledge is commonplace because it is on a government website flies in the face of most common experience. How many people know that when you buy a house you are supposed to negotiate on your personal title insurance but can’t negotiate on the lender’s title insurance? Consumer protection regulation ought to start with the reality of knowledge—not an assumption of perfect information.
Unaware that they are able to negotiate the price of a car loan from their dealership, many consumers simply accept the terms they are given. This helps explain why consumers often end up with higher interest rates from in-direct lending. As a September 2013 Bipartisan Policy Center (BPC) report found:
“The auto-financing marketplace is a complicated market. There are similarities to the mortgage market, where some mortgage brokers had an incentive to place borrowers into higher interest rate products. Most vehicle financing begins when auto-dealers submit basic information to financial institutions on the creditworthiness of an interested car buyer. Financial institutions respond by providing auto-dealers with an interest rate they believe fits the buyer’s risk profile; but this interest rate is not always shared with the borrower. In some instances, the difference between the financial institution’s interest rate offer and what the consumer actually receives becomes profit to the dealer. These costs to consumers may be substantial.”
Whether these higher costs total $26 billion, which is one estimate by the Center for Responsible Lending (CRL), or less , misses the underlying point: similar loans should be subject to similar consumer protection standards regardless of whether they are sold directly from a bank or indirectly through a car dealership.
A key difference is whether the Equal Credit Opportunity Act (ECOA) applies. When a bank makes a direct auto loan ECOA applies. When a car dealership arranges, but does not make the loan, ECOA may not be enforceable against the dealer. CFPB’s current guidance is attempting to use its existing authority over banks that purchase loans arranged at a dealership (buying the in-direct loan) in such a way to have the banks better monitor auto dealers for ECOA violations and change the way dealers are compensated for arranging loans purchased by banks. ECOA in general provides protection against discrimination for a host of factors, including race, marital status, religion, gender, etc…
The upshot is that a higher standard of consumer protection from the CFPB’s rules for bank offered loans but not from indirect loans has created market place distortions that are bad for consumers, and as we saw in the mortgage meltdown, can ultimately be harmful for everyone. Furthermore, there may be particular concerns for minority borrowers, as BPC found: “Pricing differences in auto lending appear to be a real, not a theoretical concern, and academic work on this subject has shown that indirect auto lending disproportionately burdens African Americans and Hispanics relative to white borrowers. However, such a marketplace disparity should be addressed directly against auto-dealers, not indirectly by attempting to regulate the business relationships that regulated lenders have with such auto-dealers.”5
What makes no sense is why these loans, direct or in-direct, should be subject to different consumer protections. If you were going to argue against a level playing field, the starting point ought to be higher levels of consumer protection for in-direct lending, where the consumer is often unaware of the need to even negotiate.
The simplest solution is to have one set of rules and expectations govern all auto loans, regardless of what type of institution is extending the credit. That is why BPC’s report recommended “the Bureau should be able to regulate auto financing directly, rather than being forced to indirectly attempt to regulate the car’s financing terms through the interactions of auto-dealers with financial services providers. Thus, BPC’s Consumer Protection Task Force calls on Congress to consider legislation to explicitly prescribe CFPB authority to regulate similar transactions in a similar fashion, regardless of whether they occur in an auto dealership.”6
1 United States. Department of the U.S. Treasury. Financial Regulatory Reform, A New Foundation: Rebuilding Financial Supervision and Regulation.
2 Bipartisan Policy Center. The Consumer Financial Protection Bureau: Measuring the Progress of a New Agency. Publication. 37. https://bipartisanpolicy.org/wp-content/uploads/sites/default/files/BPC%20Consumer%20Financial%20Protection%20Bureau%20Report.pdf.
3 While we always suggest competitively shopping between institutions for the best interest rate, which often includes negotiating on fees with all providers, it is generally the case that banks have fixed interest rates that they offer given consumers based on product and risk. Rarely does one negotiate directly with a bank over an interest rate, although negotiating over fees can be far more common.
4 Federal Trade Commission. “Consumer Information.” Understanding Vehicle Financing. Accessed May 12, 2015. https://www.consumer.ftc.gov/articles/0056-understanding-vehicle-financing.
6 Bipartisan Policy Center. The Consumer Financial Protection Bureau: Measuring the Progress of a New Agency. Publication. 38. https://bipartisanpolicy.org/wp-content/uploads/sites/default/files/BPC%20Consumer%20Financial%20Protection%20Bureau%20Report.pdf.