Hidden Auto Finance Markup:
The Costs and Impact on New Jersey Consumers
February 2005
• What Is Auto Finance Markup?
• Finance Markup Practices In New Jersey
• Auto Finance Markup In New Jersey Is Part Of A National Trend
• Auto Finance Lending Practices Must Be Corrected
• Advice to Consumers
• Summary Sheet for this Report (new page)
• Press Release regarding this Report (new page)
What Is Auto Finance Markup?
A hidden but widely practiced markup of auto finance rates encouraged by the auto industry's finance companies and banks at the time of the sale has cost New Jersey car buyers tens of millions of dollars and all American consumers hundreds of millions of dollars. Additionally, the practice has resulted in a well-documented discriminatory impact on African-American and Hispanic borrowers, who are statistically more likely to pay the markup and whose markups are on average higher than their White counterparts.
Auto loan markups occur when lenders allow car dealers to subjectively increase the interest rate on auto loans above the "buy rate" determined by the actual creditworthiness of borrowers. The subjective markup is then shared between the dealers and the finance companies. A growing body of evidence shows that hundreds of thousands of consumers, perhaps millions, have trusted auto finance companies and car dealers to charge them fair and reasonable rates only to then be subjected to markups that, in the past, have even exceeded five percentage points. A report, which was released by the Consumer Federation of America, the National Council of La Raza, and the Rainbow-PUSH Coalition in January 2004, estimated that these overcharges cost consumers at least $1 billion annually.
Laws prohibit the nondisclosure of similar "yield spread premiums" or commissions for mortgage lending, but do not apply to undisclosed markups in auto financing. For many, a car is one of the largest purchases ever made. Most people buying cars worry about negotiating the purchase price, but many consumers who finance their purchase at the dealership are unaware that the rate quoted to them may be negotiable and that the dealer may be participating in the distribution of the interest payments.
Finance Markup Practices In New Jersey
At this time, it is impossible to determine the total impact of the markup on all New Jersey car buyers. However data is available that shows tens of millions of dollars of markup costs to New Jersey car buyers from three auto finance companies: Nissan Motors Acceptance Corporation (NMAC), General Motors Acceptance Corporation (GMAC) and Primus Automotive Financial Services, Inc. (PRIMUS), a division of Ford. Studies of these lenders prepared by Dr. Mark Cohen of Vanderbilt University, filed in relation to lawsuits alleging racial discrimination in the markup, examine the impact of the markup on White, African-American and Hispanic borrowers. The studies show a significant impact of the markup on New Jersey consumers.
The studies by Dr. Cohen demonstrate that the impact of the auto finance markup on New Jersey consumers in the past to be as follows:
|
Lender
|
Period
|
Number of NJ Contracts
|
Total NJ
Markup $
|
Average NJ
Markup $
|
Average National Markup $
|
|
GMAC
|
01/1999-04/2003
|
34,473
|
$23,809,038
|
$691
|
$627
|
|
AHFC
|
06/1999-03/2003
|
39,079
|
$29,206,816
|
$747
|
$702
|
|
PRIMUS
|
01/2001-02/2004
|
30,092
|
$13,732,400
|
$456
|
$498
|
Among 30,092 New Jersey borrowers impacted by the markup in the study of PRIMUS lending, the average markup percentage was 1.02 percentage points and the average markup fee was $456. In some of the most extreme cases outlined in the PRIMUS report, before a 3% cap was introduced, the markup cost New Jersey consumers thousands of dollars in additional, hidden costs. For example, for a consumer who choose to purchase a particularly expensive car, a markup of 3.15 percentage points on a 72 month loan of $85,371 yielded a $10,484 markup; the buy rate for this borrower was 11.75 percent and the APR after the markup was 14.90 percent. In another example, a markup of 8.00 percentage points on 36 month loan of $6,362 yielded a $943 markup; the buy rate for this borrower was 13.00 percent and the APR after the markup was 21.00 percent.
A study of Nissan Motors Acceptance Corporation (NMAC)contained information specific to New Jersey on the racial disparity of the markup, comparing Black to White consumers. This study determined that during the period March 1993 through September 2000, the average markup of a Black NMAC customer was $799, as compared to $460 for the average markup of a White NMAC customer, a difference of $339.
It should be noted that NMAC, GMAC and AHFC have all settled private litigation alleging that the mark-ups charged by dealers on their loans have all led to higher mark-ups charged to Black and Hispanic auto buyers than to White auto buyers. The three firms have agreed to cap the markup and market a substantial number of no mark-up loans to Black and Hispanic buyers. Discrimination cases against Primus and its corporate parent Ford are pending.
Auto Finance Markup In New Jersey Is Part Of A National Trend
The national trend of racial disparities and consumer costs caused by the markup is well documented. For example, a study by Dr. Cohen filed in January 2004, in relation to a lawsuit alleging discrimination in the markup practice by Ford Motor Credit Company, shows that 30.9% of white customers received the markup, versus 48.5% of African-Americans. African-American borrowers on average pay more than 2 times the amount in subjective markup compared to whites: $684 versus $337, a difference of $347.
In another example, the September 2004 study by Dr. Cohen of nation-wide lending by PRIMUS, it was found that 40.2 percent of White borrowers were charged a subjective markup, compared to 57.9 percent of Hispanic borrowers and 62.8 percent of African-American borrowers. The average markup was $715 for Hispanic borrowers, compared to $464 for White customers, a difference of $251. African-Americans paid on average $862 in the markup compared to $475 for Whites, a difference of $387. Other findings of the PRIMUS study include:
- The 219,278 PRIMUS borrowers who were identified as either being African-American or White were charged a total of $118 million in subjective markup. Of that total, $30.9 million, or 26.1% was charged to African-Americans, who make up only 16.3% of this customer base.
- 3,198 PRIMUS customers in the race-coded sample were charged more than $3,000 in subjective markup. African-Americans make up 31.6% of those who were charged more than $3,000, although they again represent only 16.3% of the borrower pool.
- Subjective markups can cost certain customers thousands of dollars. For example, one African-American customer in Florida financed a Toyota Sequoia through PRIMUS and borrowed $36,718 for 60 months. This customer had a tier 2 credit rating and should have qualified for a loan rate of 11.7%. The loan was marked up by 5 percentage points to 16.7%. As a result, monthly payments were nearly $100 more per month than they would have been if the loan had not been marked up. The total subjective markup over the life of this loan was $5,863.80.
- The average subjective markup for African-Americans was $930 in 2001; $872 in 2002; $699 in 2003; and $498 in 2004. The average subjective markup for Whites was $542 in 2001; $445 in 2002; $397 in 2003; and $343 in 2004. This decline in mark ups appears to reflect PRIMUSÕs lowering its cap on allowable markup to three percentage points in 2003, but the numbers also show that racial disparities in the markup remain.
The report examined records of 219,278 PRIMUS customers over the period, January 2001 to February 2004.
Auto Finance Lending Practices Must Be Corrected
In response to litigation and requests by consumer groups, state attorneys general, and even industry experts to end the markups, several auto finance companies have revised their lending practices. For example, Nissan Motors Acceptance Corporation settled a lawsuit alleging discrimination by limiting the markup to 3 percentage points and 2 percent for longer-term finance agreements and 2 percent for used vehicles. General Motors Acceptance Corporation imposed a 2.5 percentage point cap on the dealer markup as a result of a settlement negotiated in a lawsuit alleging discrimination in the markup. Ford Motor Credit Corporation subsequently self-imposed a lower cap of 2.5 percentage points following findings of discrimination and consumer gouging in FMCC auto finance markup practices.
Notably, the PRIMUS report presents evidence that suggests caps do not end racial disparities and the potential for high consumer costs. During the 2001 to 2004 time period examined by the PRIMUS report, PRIMUS self-imposed a lowering of a cap on the markup from 5 percent to 3 percent on standard term loans (those of 60 months or less), effective March 1, 2003. But throughout the entire 2001-2004 period, African-Americans were consistently charged a higher markup than Whites at statistically significant levels regardless of which credit tier they fall under. In other words, while the lower markup cap has the effect of reducing the disparity between White and African-American markups, it does not end the disparity altogether and still leaves the possibility of high dollar markups for all consumers.
Moreover, the imposition of markup caps does not necessarily prevent consumer from continuing to pay substantial markup fees. In one example of a New Jersey car buyer in the PRIMUS report, a markup of 2.25 percent on a 72 month loan of $46,791 yielded a $4,030 markup; the buy rate for this borrower was 11.00 percent and the APR after the markup was 13.25 percent.
Reforming the practice of the markup has been an important step, but given the continued high fees that even 2.5 and 2.0 percent markups can yield, more remains to be done. Many consumer education efforts have been undertaken and funded by the auto loan finance companies as part of legal settlements, but consumer groups still object to auto loan markups in principle. In a recent statement, Stephen Brobeck, executive director of Consumer Federation of America, said, "Creditworthiness is entirely taken into account by the buy rate at which lenders are prepared to extend credit to car buyers." "Dealers should be permitted to charge lenders a reasonable processing fee but not to arbitrarily mark up loan rates above the buy rates and to do so without disclosing these markups," he added.
Dealers ought to be fairly compensated for helping consumers with their credit application. However, the current system is not the way to do this. By tacking on points to the annually compounded interest rate of a loan, dealers arbitrarily make more money based upon the amount of the loan and the length of its term. This stands in no relation to the amount of effort required to help with loan processing.
Consumer groups have suggested the right answer is compensating dealers with a flat fee that is disclosed at the time of the loan. Some have suggested a percentage markup could also work if it is disclosed and is a one time payment based on the loan amount.
The automobile industry has in its power to end the current practice of the finance markup charge, which would eliminate discrimination and improve fairness in lending.
Advice to Consumers
In order to avoid being a victim of finance markup charges at the car dealer, consumers are urged to check with their bank or credit union before seeking auto financing from a car dealer.
After selecting a car model, car buyers should call their bank or credit union for a rate quote. Then compare it to the dealer's quote. It is essential here that the buyer, not the dealer, make the call to the buyer's financial institution.
If the dealer offers zero percent financing, they will not give consumers a rebate on the sale price. Car buyers should ask their bank or credit union whether it makes sense to take the rebate and finance the purchase at the regular rate. Then compare their calculations with those of the dealer.
For additional information, please contact the New Jersey Citizen Action or Consumer Federation of America.
This report was prepared by New Jersey Citizen Action, New Jersey Citizen Action Education Fund and Robert Brandon, President of Brand & Associates, consultants to Consumer Federation of America.
