With President Obama set to sign a new financial oversight bill into law on Wednesday, the New York Times has dug into the bill looking for key oversights. Because auto dealers were exempted from the bill (thanks at least in part to their mobilization by the GM/Chrysler dealer cull), auto dealer finance tactics ended up square in the NYT’s crosshairs, and paper’s Your Money blog has a rundown of three of the most heinous of these tactics: the Yo-Yo, the Markup and the Add-On.
The Times describes the “Yo-Yo” as”rare, but truly insidious,” and explains it thusly:
Consumers sign contracts agreeing to an interest rate and price and drive away from a dealership thinking a deal is done. Not long after, they get a call asking them to come back to the dealership. Once dealers reel them back in (hence yo-yo), they say the financing has fallen through and try to get consumers to sign new contracts with higher interest rates…
Often, a dealer will quote an interest rate from a bank or finance company to a consumer, and the buyer signs a contract. Only then does the dealer get official approval from the lender who provided the rate quote. Every so often, lenders change their mind (or dealers do, lawyers say, because they may be able to make more money by arranging a higher-interest loan elsewhere and shoving it down the throat of a frightened buyer who needs the car to get to work).
The Times implies that such tactics should be subject to regulation by the new Consumer Protection Agency, but argues that in the absence of legal protections, consumers should seek independent financing from credit unions or banks. This is definitely not what the industry wants you to hear, as dealer and in-house finance is typically far more profitable (thanks in part to tricks like this) than the cars themselves. Still, arranging private financing is an excellent choice for any new car buyer looking for an honest deal without a lot of financing-related runaround.
The NYT describes the Markup problem thusly:
One thing consumers may not realize when applying for an auto loan through many dealers is that it’s often the dealers, not the company providing the loan, that ultimately decide how much you’ll pay. A bank quotes a wholesale rate to the dealer, and then the dealer is free to mark it up by as much as 3 percentage points. The dealer’s ultimate profit on any deal depends in part on how much it marks up this rate.
The problem, as the Times points out, is that these markups tend to be arbitrary and capricious.
That spread used to be higher, before a number of lawsuits using data from as recently as 2004 revealed that blacks and Hispanics were paying more for their loans, even when they had the same credit scores as whites. And in case you didn’t believe that everyone’s a little bit racist sometimes, lawyers in one lawsuit determined that minority-owned dealers had the biggest markups, according to Stuart Rossman of the National Consumer Law Center in Boston, who was co-counsel on the cases.
If that’s not a can of worms, what is? And once again, the solution is older than time: caveat emptor. OEMs and dealerships have every incentive to make financing part of your car-buying decision, and they have any number of attractive-looking incentives for you to buy a certain car. Ultimately, though, arranging financing before you even begin hitting the lots is the best way to make sure that your lender keeps your best interests (rather than, say, their dealership’s profitability) at heart. Borrowing from small institutions like credit unions might not seem like the best way to get a screaming deal, but since they’re member-owned, they tend to have a much better record when it comes to fair lending practices.
Finally, the last major scheme not covered by the Financial Reform Bill is an old dealer favorite: the Add-On. And if you’ve ever bought a car from even the most up-and-up dealership, you’ve had a sales manager try to add undercoating, window etching, service contracts or some other worthless tacked-on fee after you’ve essentially come up with a deal. This, according to the NYT, is a popular scheme because it works even when a shopper has been smart and arranged their financing ahead of time. After all, if a dealer can’t squeeze you on APR or a financing Yo-Yo scheme, they’ve got to make some real profit somewhere… and add-ons have always been the last resort for a car-dealing scoundrel. The only protection a consumer enjoys from such schemes: The Nancy Reagan. Just say no.
We weren’t thrilled to see the Financial Reform Bill pass without coverage of dealer financing for the simple reason that the industry has a bad enough reputation as it is. Everyone knows the archetypal buy-here-pay-here sleazeball dealer, and carving these fine businessmen out of a lending reform bill is the best way to perpetuate the stereotype… at a time when consumers have few feelings of sympathy for the plight of the car business. But here’s the silver lining: at least car buyers won’t be burdened by the expectation of a government-guaranteed hassle-free buying experience. The old “buyer beware” maxim has been all a car buyer could rely on since the dawn of the industry, and at least this bill doesn’t give anyone the excuse to pretend like that’s changed.