The Consumer Financial Protection Bureau 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. The fact that consumers are unaware of the additional interest makes it difficult to negotiate prices fairly with full information. These fees add more cost to the consumer and more profit for the dealer.
For consumers, it's 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, 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.
It is also yet another sign that 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). ECOA makes it illegal for a creditor to discriminate in any aspect of a credit transaction on bases including 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 how African-Americans and Latinos disproportionately received interest rate markups more frequently and to a greater degree than their similarly-situated white counterparts.
CRL also found that consumers pay over $25.8 billion in interest rate markups over the lives of their loans. Beyond higher mark-ups, poor credit ratings can lock consumers into finance rates so high that repossessions become the norm, rather than the exception.
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 total markup volume during this same period grew 24 percent from $20.8 billion in 2007.
Now, thanks to the CFPB's watchdog role if or when financial violations occur, dealers are assured that swift enforcement will be taken.
Further, 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.
CRL salutes the CFPB for exercising their power to ensure that the marketplace is fair for all consumers. 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