The Consumer Financial Protection Bureau (CFPB) is holding auto lenders who offer financing through dealerships responsible for “unlawful, discriminatory pricing.”
CFPB is claiming that there is racial discrimination in the way dealers determine their customers’ interest rates. However, dealers strongly disagree that they practice such against legally protected classes of borrowers which include women and minorities.
According to the CFPB, lenders allow discrimination when they give dealers discretion over retail interest rates.
“Lender policies that provide dealers with this type of discretion increase the risk of pricing disparities among consumers based on race, national origin, and potentially other prohibited bases. Research indicates that markup practices may lead to African Americans and Hispanics being charged higher markups than other, similarly situated, white consumers,” says the CFPB.
Noteworthy is the fact that dealers are incentive-driven in marking up the interest rates as a higher rate translates to a greater share in the profit from the final interest rate.
In their bulletin released March, the CFPB warned auto lenders that they may also be liable under the disparate impact theory where lending practices tend to include charging of higher interest rates to protected classes. CFPB director Richard Cordray said the discrimination does not have to be intentional.
Dealers disagree with the term “dealer markup” and prefer “dealer reserve” for the value they add to the ceiling rate provided by lenders. For them, the former sounds like they are just charging extra for no work.
Dealers, who often act as the middleman, usually send their customers’ credit application to several lenders—a huge convenience to consumers. In effect, it keeps the rates low as competitors vie for the borrowers’ business. The rates, then, negotiated at the dealership with the dealer acting as the middleman beat the rates in direct loans from banks.
According to the National Automobile Dealers Association, changing the system may only suppress the competition and cost consumers more.
Meanwhile, the CFPB makes it clear that it agrees dealerships need to be compensated for the work they do in negotiating loans for consumers. What they don’t approve of is the discretion given to dealers in imposing interest rates in the market.
The bureau says such practice results in two borrowers receiving different rates even though both have the same credit standing and capability to pay. The CFPB then suggests setting a flat fee for dealers’ work of negotiating loans instead of allowing dealers to set the rate.
However, no one can tell whether or not the flat fee would suffice as replacement for the so-called dealer reserve.
Dealerships are allowed to add up to 2.5 percentage points to the ceiling rate depending on the loan term. However, NADA said that the dealer reserve hardly reaches the ceiling.
The CFPB’s ongoing actions may result in either lower ceiling or flat fees.