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Why Getting Loan at Auto Dealer May Be a Bad Idea

By Aaron Crowe

Having a loan in hand before walking into an auto dealership is a common recommendation when buying a new car. It can keep you from being offered financing by the car dealer, who can add fees you might not recognize.

Some buyers, however, welcome the chance to negotiate finance terms with a lender through their car dealer, saying they can get a lower interest rate than they would through their bank.

Such decisions may lead to discriminatory practices against consumers when finance companies authorize the dealer to mark up the interest rate that can lead to different interest rates for similarly situated consumers, according to the Consumer Financial Protection Bureau. Discriminatory markups on auto loans may result in tens of millions of dollars in consumer harm each year, according to the CFPB.

The CFPB is proposing to oversee larger non-bank auto finance companies for the first time at the federal level. In a proposal it made in September, the CFPB said it wants to supervise non-bank auto finance companies that make, acquire or refinance 10,000 or more loans or leases in a year. It estimates about 38 auto finance companies would be subject to the new oversight, and that they originate around 90% of non-bank auto loans and leases. In 2013 they provided financing to 6.8 million consumers.

“Many people depend on auto financing to pay for the car they need to get to work,” says CFPB Director Richard Cordray in a statement. “Non-bank auto finance companies extend hundreds of billions of dollars in credit to American consumers, yet they have never been supervised at the federal level.”

How loans are financed

Auto loans are financed by bank and non-banks. You can get a loan directly from your bank, called direct financing, or you can get indirect financing where an auto dealer typically facilitates a loan from a third party. Banks, credit unions and non-bank auto finance companies provide credit to consumers both directly and indirectly.

Some non-bank finance companies are “captive” non-banks, meaning the finance companies are owned by auto manufacturers that generally do only indirect lending.

Nearly 90% of the U.S. workforce commutes to work by car. Auto loans are the third largest category of household debt, behind mortgages and student loans. The average loan for a new car is almost $27,000, according to the CFPB.

How auto dealer financing can backfire

Stephanie Jadotte, a partner and creative director at Jadoly Branding and Marketing, says she financed her first new car in September 2008 when she bought a 2009 Honda Accord coup, and saw how a dealer tried to give her a worse deal than originally promised. The dealer offered the best finance rate she could find at the time — 2.9% financing. The lowest rate she found at a bank was 4%, Jadotte says, so she went with Honda’s financing company.

Things quickly got worse. Even though Jadotte had a very high credit score and qualified for the low promotional rate, the finance person she was handed off to by the salesman “tried to finance my car with another bank instead of Honda with a higher rate,” she says, either 7 or 8 percent.

He tried shopping her loan at two banks at first, and every time was a hard inquiry on her credit, which can lower a credit score. He told her that the banks gave him the high rates and that he had no control over what she qualified for, Jadotte says. Eventually, he told her that she didn’t qualify for the promo rate because her credit report showed that she had never financed a car before.

Jadotte and her father, who was helping her shop for a car, “called him out on that because my score was good enough to warrant the promo rate,” she says. When the finance guy replied that the best he could do was 7%, they walked away from the table and said they’d go to another dealer.

He then got her the 2.9% promo deal that she was told she’d get from the beginning, and Jadotte was happy with her new car.

“So I purchased the car and was very happy with it, but I was not happy with the process I went through just to obtain the loan at a rate I knew I qualified for,” she says. “They tried to do the old bait and switch.”

Aspects of oversight being sought

The CFPB already supervises large banks making auto loans, but not non-bank auto finance companies. It wants to ensure auto finance companies treat consumers fairly throughout the life of a loan by:

  • Fairly marketing and disclosing auto financing: The CFPB wants auto finance companies that market directly to consumers to not use deceptive tactics to market loans or leases. It also wants consumers to get terms they understand and accept.
  • Providing accurate information to credit bureaus: The CFPB recently took action against an auto finance company that distorted consumer credit records by inaccurately reporting the consumer’s payment history and delinquency status to credit bureaus.
  • Treating consumers fairly when collecting debts: Consumers have complained to the CFPB about having their autos repossessed while they are current on the loan or have a payment arrangement in place.

Aaron Crowe is a journalist who covers the auto industry for CheapCarInsurance.net.