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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Dec 10, 2020

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The CFPB is gearing up to change lending rules for auto loan lenders in 2014.

The Bureau alleges that dealer reserve, which is a kickback dealerships receive for charging consumer’s higher interest rates on auto loans, is little more than a ripoff to consumers.

In place of this, the CFPB wants to create a flat fee policy that would replace dealer reserve and also prevent lending discrimination.

Senator Elizabeth Warren (D-MA) is one of the strongest voices calling for auto loan rule changes, having stated in the past that auto loan borrowers are tricked out of billions of dollars each year.

In response to this, the National Automobile Dealers Association (NADA) has countered that the CFPB has not revealed how it even knows that discrimination is occurring in the auto loan market. Additionally, NADA states that it fully supports the nation’s fair lending laws and is committed to working with federal agencies to eliminate discrimination in the marketplace.

Bailey Wood, Spokesperson for NADA, expanded on the organization’s statements and defended the practice of dealer reserve.

“Our perspective is that dealer reserve increases access to credit,” he said. “Dealers have the ability to meet or beat a bank’s interest rate. If Warren has her way, the ability of dealers to discount loans would be gone. What the Senator wants to do is eliminate 17,000 auto loan discounters from the marketplace.”

Wood explained that indirect-financing helps consumers by offering increased competition between lenders. This is because dealers are able to access lenders that the general public is unable to get to. Since different lenders try to outbid each other, they push the price down for consumers.

“On average, we’ve looked at actual transactional data, the average customer saves 0.7 percent on a used car loan and a whole percentage point on a new car loan,” said Wood.

Should the CFPB end interest rate competition, he fears that consumers would ultimately suffer, not dealerships.

“What a consumer pays is going to go up dramatically,” he said. “If you reduce competition, prices go up. People are not gonna be able to negotiate a lower interest rate.”

Wood pointed out that car buyers can already walk into dealerships with financing in hand, such as from a credit union or bank. With this financing, they have a bargaining chip to hold over a salesman’s head and push for a lower interest rate. Some dealerships will try to beat the financing that a customer walked in with in order to gain the customer’s business. Wood himself purchased a vehicle in the Summer and after showing a dealership the financing he walked in with, the dealership beat it by one whole percentage point.

As far as the CFPB’s flat fee concept that would supposedly end discrimination in auto loan lending, Wood is far from optimistic.

“Dealers will go with whoever has the highest flat fee,” he said. “Right now consumers can negotiate better interest rate than if a flat fee existed.”

One expert with a history working in car dealerships couldn’t disagree more.

Brian Massie, a Communication Consultant and former Ford Salesperson, said that ending dealer reserve is a good idea.

“The Finance and Insurance Department of a dealership is where a lot of the money is made because of the lack of consumer information,” said Massie. “That being said, these practices are due in part to the forced disclosure about all other financial aspects of a vehicle purchase transaction. One cannot, for example, walk into a furniture store armed with all information pertaining to how much the store paid for the items on display. For some reason, people are able to do that with automobiles.”

Massie qualified his remarks by stating that he is supportive of full disclosure in lending but against full disclosure of dealership pricing. He postulates that if dealer reserve is eliminated, it will reduce the amount of predatory lending practices by primarily smaller dealerships who need to make every penny possible off every sale since they do not do the sales volume needed to generate a strong net bottom line.

“Those dealers who do not participate in this practice will not be initially affected but in time they will see a benefit as other dealers close and reduce competition,” said Massie. “It is up to the consumer to decide if they are better off with more disclosure at the expense of less competition.”

However, the threat of imposing flat fees upon dealerships in place of dealer reserve is something that trade groups like NADA fear.

“On its surface, a flat fee sounds like a good idea,” said Massie. “However, due to cost of living differences depending on a given area, the effect wouldn’t be uniform. Thus I don’t think it would be the best idea.”

Massie explained that dealers are trained to “take the rebate, skip the lower rate” by explaining to customers that by taking the rebate they are financing less money and not facing any early payment penalties on their auto loans. Any consumer who complains about offered interest rates is told that they can try to work with a bank or credit union to get a better deal to beat the dealership’s offer.

“Car dealerships are like mortgage brokers in that, once the loan has been created it is an asset,” said Massie. “The dealership gets paid a commission from the finance company for closing the deal and creating that asset.  People are often under the assumption they can’t make a different deal with another lending institution once they locked in with a given finance company.  But, just like in the case of a homeowner, any auto loan be refinanced.”

Regarding the CFPB’s allegations of discrimination, Massie believes that the only color dealerships care about is the color green.

“During my time as a salesperson I never knew of any discriminatory practice to take place,” said Massie. “If one buyer has an advantage over another buyer, financial resources being equal, the better informed consumer will always spend less.”

New Rules, New Problems

Rob Drury, Executive Director of the Association of Christian Financial Advisors, said that the CFPB’s allegations of discrimination are completely unfounded and that the CFPB’s plans might end up making it harder to buy a car.

“First of all, auto financing is simply a consumer good and the market is fiercely competitive,” said Drury. “Loans are bought on a wholesale basis and sold at retail, just like any other product. The appropriate price is determined by the required profit margins of the wholesale and retail entities, and by the customer’s ability and willingness to shop. The two percent cap that many lenders place on dealer markup is extremely reasonable and sufficient to prevent abuse concerns, but is truly only there to maintain the reputation of the lender; a shining example of the market effectively and efficiently regulating itself.”

Even though most dealerships keep their rates fair and reasonable in order to sell more cars, if dealerships cannot depend on revenue from financing, they are less likely to sell cars if they can’t make money on car loans.

“One cannot be denied an opportunity based upon a legally protected criterion if that criterion was not part of the decision process,” said Drury. “Also, it makes absolutely no sense that a dealership would take the substantial steps necessary to sell an individual a vehicle, then take further steps to prohibit that sale from taking place.”

While observers are quick to point out that a dealership has little to do with the CFPB’s oversight or sphere of influence, the lenders and financial companies responsible for auto loan lending do.

“Granted, only the lenders in the dealership scenario are regulated by the CFPB, but the policies under which dealership can offer financing are controlled entirely by the lender, and therefore effectively fall under the CFPB’s scrutiny,” said Drury. “It would seem reasonable that the lender would be sensitive to dealers’ concerns, as dealer financing is an extremely important marketing venue for most auto lenders.”

Assuming the CFPB eliminates dealer reserve, dealers would lose a critical piece of revenue generation and would have little incentive to offer occasional deals. Customers would also lose financing options as unprofitable auto loan lenders dissolve.

“Elizabeth Warren has consistently shown a disdain for business, and it would appear that nothing in her vision of the CFPB is designed to better the business environment,” said Drury. “She has no grasp of the fact that what is bad for businesses is almost always bad for the consumer as well. The customary two percent cap on dealer reserve is extremely reasonable, and has no significant effect on the buyer in the purchase of a vehicle. It can, however, make or break the possibility of a car deal.”