New research by the Center for Responsible Lending (CRL) finds that consumers of color still report paying higher interest rates on dealer-financed car loans than other consumers. This disparity is even more disturbing given that Black and Latino consumers report making more of an effort than Whites to negotiate their interest rates. Thirty-nine percent of Latinos and 32 percent of Blacks reported negotiating their interest rate, compared to only 22 percent of White buyers.
CRL’s new report, Non-Negotiable: Negotiation Doesn’t Help African-American and Latinos on Dealer-Financed Car Loans, is the first research on the impact of shopping habits as well as information consumers report receiving from car dealers and disparities related to “add-on” products. Findings were based on an October 2012 phone survey of 946 consumers.
The report identifies three specific sales practices as the main culprits behind higher financing costs for buyers of color:
Dealer interest rate mark-ups, sometimes called “dealer reserves” or “dealer participation” can and do raise interest rates above those charged by financial institutions. Lenders bidding to buy the auto loan contract from dealers allow the dealer to add to the interest rate for compensation. Dealers then pocket most or all of the difference. As with a similar practice once allowed for mortgage brokers, this discretion to raise interest rates can facilitate discrimination. Previous research shows that people of color get higher interest rates from dealers that are not justified by objective measures, such as credit history.
Misleading sales information is a second cause of higher costs. For example, many consumers report they were told that they were offered the “best interest rate available,” when it was not. Other consumers surveyed shared that they were told that certain additional items were mandatory for the purchase when in truth, the items were not. Misrepresentations, when accepted by consumers, can increase the total purchase price and then lead to higher default rates.
Similarly, “add-on” products sometimes known as “loan-packing” also increase the amount of financing. Non-essential items such as optional insurance and warranties become part of the financing package at highly-inflated costs. Multiple add-on products were sold to Black customers nearly double the rate sold to Whites – 30 percent versus only 16 percent.
Since the report’s January 23 release, auto dealer representatives have criticized CRL’s research for being based on a survey. However, the industry to date has withheld their own data that would allow better side-by-side comparisons – the same kind that consumers deserve when shopping for a vehicle.
“As long as dealers can manipulate interest rates, car loans are a gamble for consumers,” said Chris Kukla, Senior Vice-President at CRL. “Car buyers can do their best to negotiate; but they are at the mercy of dealers whose compensation is tied to hidden interest rate increases. That’s a formula for abuse."
CRL has called on regulators to prohibit compensation for dealers that is tied to the interest rate of the loan. Until regulators enact rules to better protect consumers, here are a few useful tips:
Get pre-approved loan financing. Historically credit unions and banks offer better deals than loans obtained from car dealers. And even if the dealer offers a lower rate, the dealer will look to make up the difference in sales of add-on insurance and other items. Remember that those items are not required and that all of them can be purchased later.
Don’t shop by monthly payment. Dealers have many tricks, such as making the loan term longer, that can make a monthly payment look affordable. Understand the entire cost of the loan, not just the monthly payment.
Avoid showroom fever. Buying a car is often the second most costly consumer purchase – after that of buying a home. Know the cost of insurance, registration tags and regular preventive maintenance. Every cost associated with a car should be anticipated and estimated.
Decide how much of a car loan you can afford. If your budget has little flexibility for a long-term debt, it could be better to begin a dedicated savings account to lessen the amount of a loan you will need.
Taking these steps will place consumers in a stronger bargaining position. You’ll know when to walk away from a bad deal or close on a good one. Consumers can save significant stress and costs with thorough planning and preparation.