Buyer Beware, if Auto Dealers Are Exempted from Any New Consumer Protection Rules

Auto dealers swarmed Capitol Hill yesterday, asking their Senators to exempt them from scrutiny by the proposed Consumer Financial Protection Agency. They've already won an exemption from the House. If the Senate gives them a free pass, too, it will hurt consumers and violate the principle that everyone selling loans should have to compete on a level playing field.

Community banks and credit unions generally offer lower rates on auto loans than dealers do, and with cleaner disclosure. They'd still be covered by the CFPA. Exempting the dealers from any new rules on fair lending would give them a leg up on these attractive competitors.

Such an outcome would also profit the large national banks and Wall Street firms that bundle and resell dealer loans, says Raj Date, chair of the Cambridge Winter Center for Financial Institutions Policy. For more on this, see Cambridge Winter's study of auto lending called "Auto Race to the Bottom: Free Markets and Consumer Protection in Auto Finance."

Dealers mix and match when they provide financing for cars. They might lower the interest rate, to appear more competitive with credit unions, and make up that cost by paying you less for a trade-in or charging more for the car itself.

The subprime used-car markets tend to work a little differently. Dealers get larger mark-ups on used cars than on new ones but financing is harder to come by. To finance a subprime borrower, the dealer might pay the lender a subsidy known as a "dealer discount." That obfuscates the actual interest rate the buyer pays.

For example, take a used-car buyer who needs a $5,000 loan at 18 percent. To get the money, the dealer might kick back $500 to the lender. The buyer pays interest on the full $5,000, even though the lender has actually put out only $4,500. This ploy raises the effective interest rate to 20 percent, Date says.

The dealer recovers the $500 he or she paid to the lender by raising the cost of the car or charging assorted fees.

For some subprime borrowers, dealers might provide the best terms available. Others could do better at a local bank or credit union. They can't loan-shop effectively, however, if they don't know what they're actually paying for their money. They could make a wrong choice if they think that the dealer loan costs less than is actually the case.

"Auto finance is demonstrably susceptible to unfair and deceptive practices, Date says. "This is not a close call. They should be subject to the same rules as other players." Exempting them discriminates against consumer-friendly credit unions and community banks.

I spoke with Baily Wood, director of legislative affairs for the National Automobile Dealers Association and chaperone for the dealers' visits to the Senate offices. He argues that dealers aren't lenders so they shouldn't come under additional oversight. But dealers sell and price loans, just the way mortgage brokers do, and it's the disclosure and sales practices that worry consumers. The existing regs on consumer protection haven't done the job.

If I were to bet, I'd say that the nation's 17,000 politically potent auto dealers will get their way. That makes it even more important for buyers to seek independent financing and negotiate the car price separately. As I've shown, the interest rate on a dealer loan can obscure, not illuminate, its cost. So it's not enough to compare the rate with rates offered elsewhere. After you've negotiated a price for the car plus any add-ons, compare the monthly cost of the dealer's package with the cost of financing through a bank or credit union. That's the only bottom line.

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