The Next Consumer Protection Target: Auto Loans

Subprime lending is back on the scene, but in an unlikely market. This time the risky financing isn’t covering the cost of a home, but a car. And some car dealerships have become the venue for those subprime loans.

Auto loans are the third-largest source of outstanding household debt in the U.S., behind home mortgages and student loans. In July, credit bureau Equifax Inc. said subprime auto loans climbed to an 8-year high of $46.2 billion, representing 28 percent of new car loans.

The incentive structure for those loans, and the types of people attempting to pay them off, has prompted several advocacy groups to sound the alarm and call for changes.

“There are a lot of parallels to the mortgage crisis,” said Christopher Kukla, senior counsel for government affairs at the Center for Responsible Lending, a nonprofit advocacy group aiming to eliminate abusive financial practices. “Given that we now have a market that is looking a lot like how the mortgage market looked in the leading up to the crisis, it begins to raise the question of whether there are loans being made to people where ability to repay is not being fully considered.”

But much like the mortgage lending practices in the lead-up to the real estate crash last decade, regulatory jurisdiction for investigating alleged auto loan abuses involves several federal agencies. The Consumer Financial Protection Bureau oversees the wholesale lenders that provide the funding, but has no jurisdiction over the dealers themselves, thanks to a carve-out Congress gave auto dealers in the Dodd-Frank law. Instead, the Federal Trade Commission regulates the car dealerships.

Add in the oversight powers of the Federal Reserve and the legislative authority of Congress and the likelihood of bringing about any significant changes to the process is proving to be a heavy lift for fair-lending advocates.

One solution, according to some fair-lending advocates, is to overhaul the current incentive structure that exists between wholesale lenders, which usually calculate a loan based on risk, and car dealers that are allowed to increase that rate and keep the difference as compensation.

For example, consumers with lower credit scores may find themselves charged interest rates that are 2.84 percent to 5.04 percent higher than other applicants when they purchase a vehicle through an auto dealer, according to survey data from the Center for Responsible Lending. Similarly, African Americans and applicants with incomes below $40,000 are more likely to purchase add-on features and products such as extended warranties or other services that boost the cost and the risk factor of the loan, CRL says.

“Dealers should not be compensated with an interest rate spread but rather a flat fee,” said Enrique A. Lopezlira, a senior policy advisor at the National Council of La Raza in Washington. “CFPB can do more. They could use their rulemaking power to create a rule for all lenders that would essentially get rid of this compensation scheme that lenders pay auto dealers.”

Similar fee structures for home mortgages were eliminated as a result of Dodd-Frank. But thanks to the carve out for auto dealers in the Dodd-Frank Act, CFPB essentially has its hands tied.

When the CFPB last year issued guidance for indirect auto lenders, i.e., not car dealerships, members of Congress in both parties pushed back against the move. Thirteen House Democrats signed a letter addressed to the CFPB requesting information on the methodology used for determining discrepancies for loans extended to different demographics. Thirty-five House Republicans signed a similar letter.

Tim Pawlenty, chief executive officer of the Financial Services Roundtable, which advocates for U.S. banks, insurance firms and credit card companies, also questioned CFPB’s analysis process during an interview last month with Morning Consult.

“How the CFPB is going to tackle that, what methodology they’re going to use, what expectations they’re going to have is all kind of opaque at the moment,” Pawlenty said. “That’s causing a lot uncertainty in the market about: How should we provide that financing? What additional limitations should be around it? What’s our role in training and supervising each transaction in a dealership when we’re really not the dealer?”

The National Automobile Dealers Association disputes that a flat-fee structure would resolve the incentive issue. They say it would shift the process from dealers deciding how much to increase the interest rate to picking the best flat fee offered by financiers.


NADA also rejects the argument put forth by fair-lending advocates that says auto dealers should disclose to consumers any differences between the loan conditions offered by wholesale lenders and the loans offered by car dealers.

“As the Federal Reserve Board concluded when it examined this issue in 1977, disclosing a business’ retail margin – or any element of a retail price – does not assist consumers when comparing different offers of credit,” Paul D. Metrey, chief regulatory counsel for NADA, said in an email to Morning Consult. “In fact, such a proposal can result in consumers choosing more expensive credit products.”

Overall, he said, “we are not aware of any credible evidence that demonstrates or even suggests that abusive lending practices are widespread or prevalent in the indirect vehicle financing industry.”

Alongside all this are allegations that minority applicants are being unfairly charged higher interest rates, whether intentionally or not. Advocacy groups, however, face a rough road ahead in making their case due to a lack of agreed-upon data. Whereas mortgage lending practices can be tracked through federal data, no such requirement exists for car dealerships and auto loans.

NCLR and consumer advocacy groups point to a settlement last year with Ally Financial Inc. and Ally Bank, as well as a similar one with General Motors Acceptance Corporation (GMAC) in 2004, as evidence of continued discrimination in the auto lending industry. In December 2013, the CFPB and Justice Department ordered Ally to pay $80 million in damages and $18 million in penalties for charging higher interest rates to more than 235,000 minority borrowers. That marked that largest auto loan discrimination settlement in U.S. history.

More recently, General Motors Financial and Santander Consumer USA Holdings Inc. said they each received subpoenas from the Justice Department in connection with the securitization of subprime loans.

While fair-lending advocates welcomed that step, disclosed earlier this month, some acknowledged that the overall battle is an uphill one that isn’t likely to yield significant results anytime soon.

“Hopefully Congress will reconsider the carve-out they gave auto dealers, but we’re not going to hold our breath on that one,” Lopezlira said. “We’re going to continue to push that dealers act like lenders and ought to be under the purview of the CFPB. It’s not going to happen overnight.”

Others said they see some momentum building.

“You’re starting to see a lot of people wonder why we aren’t doing more to get in front of this issue,” Kukla said. “It’s an issue that’s a little bit complicated, and I think it’s one of those where regulators are trying to figure out where to jump in.”

Morning Consult