December 1, 2023

Bucks: Getting the Best Rate on a Car Loan

Jim R. Bounds/Bloomberg News

When it comes to buying a car, you’re often far better off seeking a loan directly from a bank or credit union than going through the dealership, because dealers often add hidden finance charges.

That’s the conclusion of a report on car dealer financing from the Center for Responsible Lending.

The group examined data from bonds backed by car loans and survey information from 25 auto finance companies with a combined 1.7 million accounts and found that dealers often marked up interest rates but didn’t disclose the markups. In 2009, the average markup was 2.47 percentage points, and the average extra payment was $714 per consumer over the life of the loan.

As car sales dipped in the slow economy, dealers felt pressured to make more money on the “back end,” as it’s known in the industry — that is, through making car loans and selling extras like accessories and service contracts to car buyers. Car sales dropped 20 percent from 2007 to 2009, but markup volume grew 24 percent during that period — to $25.8 billion from $20.8 billion — mostly due to increased markups on used cars, the report found.

While the markups can raise the cost of new car loans, used car loans usually get higher markups, as do borrowers with less than stellar credit histories. Say, for example, a borrower’s credit score qualifies him for a 60-month used car loan of $17,500 at 8 percent interest, but the dealer adds a markup of 2.5 percent. At 10.5 percent, the loan costs $1,278 more. (That amount is much higher than the average $714 because the average includes loans with no markups. Such loans are probably made to borrowers with very good credit, or those savvy enough to know what sort of rate they would qualify for based on their credit score, said Kathleen Day, spokeswoman for the Center for Responsible Lending.)

The extra charges are often particularly burdensome for less credit-worthy borrowers, and can increase the likelihood that such consumers will default on the loan or have the car repossessed, the report said.

Yet most consumers aren’t aware that dealers can mark up rates without their consent and often don’t know what the interest rate is on their car loan. Dealer finance staff members may tell buyers the rate quoted is “the rate that is available,” rather than the “best rate they qualify for,” to avoid legal challenges over deceptive practices, the report said. Consumers who said they believed their dealer gave them the “best” loan possible actually paid rates 1.9 to 2.1 percentage points higher than others with similar credit standing.

The report proposes having finance companies pay dealerships a flat fee for arranging loans, which would compensate them for their time but reduce the potential for abuse. A federal requirement for an interest rate disclosure, like those used for mortgage loans, is also warranted, the report said. (Sounds like yet another job for the new Consumer Financial Protection Bureau)

Meantime, what can consumers do? The report makes the following suggestions:

  • Consider seeking preapproval for financing from a bank or credit union before visiting the dealership. At the very least, it will provide a point of comparison if the dealer makes a loan offer.
  • If you do obtain financing from the dealer, realize that everything in the loan is negotiable — including the interest rate.
  • Check your credit scores ahead of time to help estimate what sort of interest rate you should be able to obtain.

Have you tried negotiating finance rates with a car dealer? What was the result?

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