Claiming racial discrimination in auto lending, the Consumer Financial Protection Bureau is taking aim at one of the sacred cows of auto retailing, where dealerships in effect mark up the customer’s interest rate on an auto loan and share the profits with the lender, potentially to the tune of hundreds of dollars per loan.
It’s a sensitive topic for auto dealers and lenders, who vehemently deny discriminating against legally protected classes of borrowers, like minorities or women.
From the CFPB’s perspective, lenders open the door to discrimination when lenders allow dealers to set retail rates. Part of the thinking is that dealerships have a built-in incentive to push rates as high as possible because the higher the rate, the more they get paid for their share of the final interest rate.
The CFPB warned auto lenders in March that it is using the so-called “disparate impact” theory to look for racial discrimination in auto loans. A disparate impact means lending practices have the effect of charging protected classes higher interest rates. The discrimination doesn’t even have to be intentional, said CFPB Director Richard Cordray.
The two sides of the argument could scarcely disagree more. For starters, dealers object to the term “dealer markup.” Industry insiders call it “dealer reserve.” From the dealer point of view, the term “markup” implies the dealer is simply tacking on an additional cost to the consumer without doing any work.
In fact, dealerships typically distribute a customer’s credit application to several lenders, who compete for the business. That’s a major convenience for the customer, and the competition among lenders keeps interest rates low. Even with a dealership as a middleman, rates on so-called “indirect” loans negotiated at dealerships routinely beat rates on direct-to-consumer loans from a bank, according to dealer advocates. The National Automobile Dealers Association claims that changing the existing system could stifle competition and end up costing consumers more.
The CFPB says it accepts that dealerships add value, and the bureau agrees dealerships should be compensated for negotiating loans. What the CFPB objects to is the discretion dealerships have – within ceilings imposed by the lenders — to charge what the market will bear.
That can result in two customers being quoted two different rates, even though they have similar credit histories and the same likelihood to pay, the bureau says. Instead of dealer discretion in setting rates, one suggestion from the CFPB is to substitute a flat fee for dealers for negotiating loans. The big question for all parties is whether flat fees on average would be equivalent to dealer reserve.
This isn’t the first time auto lenders and dealers have been accused of having a disparate impact. Most auto lenders joined a series of legal settlements in class-action lawsuits in the mid-2000s, which imposed voluntary ceilings on dealer reserve. Depending on loan terms, the maximum dealerships can add to the rate is around 2.5 percentage points. In practice, due to competition dealer reserve rarely reaches the ceiling and often averages less than 1 percentage point, according to the dealer association.
The ongoing CFPB actions could result in an even lower ceiling, or else flat fees.
Views – 93