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Auto dealership advocates are warning that costs will rise for borrowers if the Consumer Financial Protection Bureau presses banks to curtail auto loan markups determined by dealers.
March 22 -
The Consumer Financial Protection Bureau is warning indirect auto lenders that they could be violating fair-lending laws by not clamping down on auto dealers who often mark up the loans they issue.
March 21 -
The Consumer Financial Protection Bureau has launched a review of alleged discrimination in auto lending. Bankers fear it will opt for punitive enforcement over rules to prevent misconduct.
June 11
Following recent changes to mortgage broker and loan officer compensation rules, the Consumer Financial Protection Bureau's bulletin on fair lending compliance in the indirect auto arena poses somewhat new, but quite similar fair lending risks.
Specifically, the bulletin addresses policies of financial institutions which allow automobile dealers the discretion to charge a contract rate in excess of the buy rate or wholesale rate charged by the financial institution to the dealer. There has been significant public discourse on the use of disparate impact theory, proxies for race and ethnicity when these data cannot be collected and the complexities of accurately assessing prices charged to protected classes under the Equal Credit Opportunity Act relative to non-protected classes. There has been little, if any, discussion on the economics of dealer services provided to facilitate vehicle purchases, particularly as compared to the services provided by a mortgage broker.
Unlike practices in residential mortgage markets, in which mortgage brokers provide the borrower with limited pre-application services, automobile dealers bundle multiple products and services into a single transaction. In the average vehicle purchase transaction, the dealer and customer negotiate prices on the new vehicle, the trade-in vehicle, financing and other insurance and warranty products. The dealers have wide discretion to establish prices on each of the products and services. Constraints on the prices charged follow naturally from the competitive market and are not generally within the control of the lender providing the financing for the vehicle loan.
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- Dealer reserve is a relatively small component of the transaction – on average approximately $350 per vehicle sold. That equates to about one-third of dealers' Finance and Insurance revenues per vehicle, with the remaining two-thirds derived from warranty and insurance products.
- From the consumer's perspective, this amounts to about 1% to 1.5% of the cost of the transaction, on average.
- Dealer discretion with respect to dealer reserve is already constrained in ways the other services and products included in the automobile bundled transaction are not. Most finance companies cap the dealer reserve at 2 or 2.5 percentage points – essentially creating a price ceiling. There are no such price controls on the other products and services priced by dealers in the transaction.
- Notwithstanding the significant discretion available to dealers with respect to the various components of the transaction, consumers are, on average, paying less for the bundle of services than the cost to dealers of providing them. That is, dealers are losing money on the sale and financing of new and used vehicles.
These findings suggest dealers have a powerful incentive to simply recoup lost revenues resulting from any further constraints on the fees they collect for arranging financing by charging consumers more for the other products or services they provide.
Unlike the wholesale mortgage market, where new broker-compensation rules serve to constrain broker discretion in charging fees to borrowers, the structure of automobile purchases provides dealers with ample discretion beyond the prices charged for arranging financing. It is worth considering how effective the new broker-compensation rules would be if the home-buying consumer purchased the real estate from an inventory of properties owned by the broker, while at the same time the broker bought the consumer's current property, sold the consumer a property and casualty insurance policy, a warranty and service contract on the house, and then eight months after the sale, the homeowner called the broker to service home improvements and repairs. This is the reality of a typical vehicle purchase and it affords the dealership significant discretion well beyond the price charged for arranging financing. The dealer has a longer relationship with the consumer, and typically earns post-purchase profits through service and maintenance services provided.
Given the structure of automotive dealer costs and revenues, great care and a deep understanding of the economics of the vehicle transaction should be exhibited when evaluating dealer discretion on one component of the transaction in isolation from the pricing discretion exhibited on the other products and services bundled in the vehicle purchase. Without this attention, application of standards may result in unintended consequences to the overall price paid by the consumer.
