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Consumer Alert: Auto Dealer Financing Red Flags

Summarized from the Center for Responsible Lending's Report - "Car Trouble:
Predatory Auto Loans Burden North Carolina Consumers".

Consumers who rely on their auto dealer to finance their loans are vulnerable to a litany of predatory practices. The dealer is usually the initial creditor in the transaction but
also arranges the sale of the loan to a bank or finance company. Without fairness and transparency in the process of financing a vehicle, consumers are subject to
manipulation that can add thousands of dollars to its cost.

Industry data also shows that every year car buyers in North Carolina are sold loans that result in over $650 million in increased interest payments over the life of the loan.

Here are four schemes to look out for while financing your car with your auto dealer:

  • Dealer Reserve: The dealer reserve is a kickback auto dealers receive for selling customers loans with higher interest rates than that for which the customer qualifies. Dealers justify markups as compensation for time spent finding financing. How it works:
    • The dealer takes a credit application from the buyer.
    • The dealer then sends the borrower information via the internet to several finance companies, asking them to bid on the installment contract.
    • The finance companies send the dealer a “buy rate,” the interest rate at which the finance company is willing to buy the installment contract.
    • The finance companies also indicate whether they are willing to pay a “dealer reserve” and the amount of the reserve offered.
    • The dealer reserve is a percentage of the value of any increase in the interest rate over the “buy rate.”
    • The reserve can be anywhere from 50% - 100% of the value of the increased interest rate.
    • For example, a finance company may offer a buy rate of 7.95% with a dealer reserve of 50%.  If the dealer increases the interest rate to 8.85%, the dealer pockets over $1000 on the deal.
  • Loan packing: Dealers inflate the overall price of the loan through overpriced add-on products including “GAP” insurance (designed to protect the buyer if the vehicle is destroyed or stolen and the value of the car is less than the remaining loan amount), vehicle service contracts, credit life and disability insurance, and theft deterrent packages. By inflating the cost of the vehicle and the size of the loan the potential kickback for the dealer is increased.
  • “Yo-Yo” scams: The buyer is either convinced to enter into or unwittingly placed in a "conditional" sale agreement rather than a final sale. After the buyer drives the vehicle home, the dealer later claims to be unable to fund the loan at the agreed-upon terms. The buyer is required to return the car and renegotiate the loan; the buyer is typically told that the down payment is non-refundable and/or the buyer’s trade-in has already been sold.
  • Binding mandatory arbitration clauses: Arbitration clauses essentially waive the customer’s right to sue and appeal in court, leaving them with an arbitration system that is more expensive for consumers and biased toward the auto industry. Ironically, auto dealers themselves have argued that binding mandatory arbitration is unfair when they successfully lobbied the federal government to prevent auto manufacturers from requiring its use to resolve franchise disputes with dealers, but still use the agreements in their loan and sales contracts with customers.

For more information on auto lending abuses click here. Here you can utilize the Center for Responsible Lending's calculator to determine the markup you might pay on a loan through a dealer.

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