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Typically, the dealer does not want to retain ownership of the retail installment sales contract and collect payments into the future. Because of this, the dealer elects to sell the retail installment sales contract to a third party, such as a finance company, bank, credit union or other investor to obtain the funding to repay the floorplan financing for that automobile. To facilitate the process, the dealer communicates with potential loan purchasers at the same time the dealer is negotiating the terms of the sale with the consumer.

Variable interest rate cards replacing fixed rates

Potential third-party purchasers make most of the common terms and conditions available to dealers in regularly published rate sheets and in the conditions of authorized dealer agreements that are typically entered into before loan purchasers agree to buy loans from the dealer. Interested purchasers then respond to the dealer with offers to purchase that contract, specifying the interest rate and specific conditions and terms that the loan purchaser will require to purchase the loan. Some third parties offer a flat fee for compensation.

Some third party purchasers cap the amount of dealer interest rate markup, while others allow unlimited markups. Some third-party purchasers charge the dealer to sell the retail installment sales contract to them, purchasing those contracts for less than face value. These programs raise entirely different issues than the dealer markup on interest rate.

Can the Federal Reserve Protect Consumers?

Instead, these programs result in dealers artificially inflating the cost of the car to recoup the discount at which the dealer will have to sell the retail installment sales contract. The characterization also paints the dealer as not in control of the process even though the dealer has the ability to choose between loans, adjust the interest rate, and structure other essential terms of the loan. The FTC should write regulations banning dealer interest rate markups in the same way that the Federal Reserve and Congress in the Dodd-Frank Act have dealt with a similar issue of compensation in mortgage lending.

The findings and substance of the rule have a direct bearing on the issue of car dealer interest rate markups. Mortgage brokers and many retail loan officers historically received compensation that varied based on the terms of the loan. This compensation increased if the broker or loan officer could convince the borrower to pay a higher interest rate than that for which the borrower qualified or accept other terms unfavorable to the borrower, such as prepayment penalties.

Unlike the car dealer interest rate markup, the actual amount of compensation paid to mortgage brokers was disclosed to the borrower. In crafting the rule, the Federal Reserve conducted consumer testing and focus groups to test the efficacy of this disclosure. The Federal Reserve had previously published proposed rules that found compensation that varied based on the terms of the loan unfair and proposed using more extensive disclosures to address the issue.

On further study, the consumer testing undertaken as part of that rule caused the Federal Reserve to withdraw the rule and instead propose and enact a rule that simply eliminated unfair compensation. The Federal Reserve determined that the practice of compensation to mortgage originators varying with the terms of the loan causes substantial injury to consumers, is not reasonably avoidable, and is not outweighed by benefits to consumers or to competition.

Of particular note, the Federal Reserve found:. Yield spread premiums, therefore, present a significant risk of economic injury to consumers… Because consumers generally do not understand the yield spread premium mechanism, they are unable to engage in effective negotiation… These consumers suffer substantial injury by incurring greater costs for mortgage credit than they would otherwise be required to pay.

Importantly, to the Federal Reserve this confusion was cause to eliminate the unfair compensation rather than allow loan providers to bury the information through confusing paperwork or in the annual percentage rate. Further, the Federal Reserve did not differentiate between mortgage brokers or loan officers of a creditor. Ample evidence exists to show that interest rate markups on car loans are routinely applied unfairly and that they disproportionately affect minority borrowers.

This method of compensation has proven to cause great problems for minority car buyers. Even when they have the same or better credit than their white counterparts, minority borrowers are more likely to be charged higher dealer markups.

Discriminatory markups have resulted in substantial class action lawsuits representing millions of black and Hispanic car buyers. Dealer interest rate markup is also a practice with significant financial impact for consumers. Further, while dealers are legally creditors, they act more like loan brokers — dealers shop loans among multiple potential purchasers of that loan and then choose one for the customer. As stated previously, dealers routinely advertise that they work with multiple lenders to obtain financing.

As such, it is very important to understand the incentives behind the transaction and eliminate those that stifle competition or put consumers in more expensive loans than necessary. The ability of the dealer to add to the interest rate for its own gain creates a perverse incentive for the dealer to push the consumer into the most favorable loan for the dealer rather than the loan that provides the lowest-cost for the consumer. This reverse competition drives prices to consumers up rather than down. This impact on the market is the same that led the Federal Reserve to prohibit this manner of compensation on mortgage loans.

A survey of more than 1, people who had purchased a car in the two years prior found that those who were either told or were led to believe that the dealer had found them the best rate in the market were charged two percent more in interest on their loans than their similarly situated peers. The only consumer disclosure about the dealer markup is a general disclosure that informs the consumer that a dealer may be gaining compensation through the interest rate and that the buyer has the right to negotiate that rate.

Consumers cannot effectively shop if the compensation system creates perverse incentives to steer consumers into more expensive loans. Rather, compensation should be based on more objective criteria that remove incentives that solely benefit the dealer. The compensation system should incent the dealer to find the lowest-cost financing for the consumer.

Dealer compensation should be limited to a flat fee from the loan purchaser or a fee based on a percentage of the amount financed with adequate disclosure of the fee. In either case, the compensation cannot be related to the terms of the loan provided, except for the size of the loan. Yes, we earn a portion of our total profit from reserve, but it provides absolutely no benefit to the customer ….

Arguments made during the roundtables that eliminating dealer markups will end financing through the dealer are specious. Dealers will still need to offer financing to sell cars, and finance sources will still seek to purchase auto finance paper from dealers. Dealers would still receive compensation for the work performed in the financing process.

Instead, there would be a transparent system where car buyers:. We urge the FTC to find that yo-yo scams are an unfair and deceptive practice. The yo-yo scam occurs when a consumer believes or is led to believe that the financing is final when in fact the dealer is not treating it as final. The dealer claims the ability to cancel the deal if the dealer decides that none of the offers by third-party assignees to purchase the finance contract are acceptable.

Conditional sales agreements, spot deliveries and yo-yo scams are three different things. In a conditional sales agreement, there is an action that the consumer must take to complete the sale, such as arranging financing to purchase car from a source other than the dealer. In some states, the dealer is required to keep the car on its insurance policy and provide use of dealer license plates until the deal is completed and title is transferred to the buyer.

Most consumers either believe that the deal is final or that the deal is as good as final. The dealer encourages the borrower to drive the car away before financing is final to remove the consumer from the marketplace. If the consumer leaves the lot thinking the contract is not final, the consumer may shop around and perhaps buy a car elsewhere. In the yo-yo scam, the dealer allows the customer to leave the lot on a spot delivery but pulls the consumer back to the dealer like a yo-yo on a string.

The consumer is then pressured to sign a new finance contract with worse terms for the consumer. It is the use of the spot delivery that allows for the yo-yo scam to occur. Spot deliveries are so pervasive that nearly every finance transaction with the dealer is a potential yo-yo scam. There are several causes that lead to yo-yo scams. In some cases, the dealer knows the chance exists that the originally-offered financing may not be available, because the third-party purchaser may send an offer with stipulations or conditions.

For example, the purchaser may want more financial information from the consumer or the purchaser may require a larger down payment or a co-signer.


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In this situation, rather than take the risk that the consumer may shop elsewhere, the dealer sends the consumer home with the car and the conditions or stipulations unmet. In other cases, the dealer does not have an offer to purchase the contract from a third-party and sends the consumer home hoping to sell the contract quickly. Or, the dealer is dissatisfied with the terms potential loan purchasers have offered.

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Consumer Financial Protection Bureau Five-Year Retrospective - Lexology

Whatever the reason for entering into this type of transaction, the goal is the same. The dealer wants to make the consumer believe the deal is final so that the consumer does not purchase a car elsewhere or decide not to purchase at all. In the typical yo-yo transaction that a dealer has claimed to cancel, the consumer is lured back to the dealership under one of several guises. When the customer returns to the dealer, the customer is presented with a new deal at a higher interest rate or with a larger down payment requirement in order to keep the car. When the dealer claims the ability to unilaterally cancel the transaction, the dealer can offer an interest rate that the dealer knows it may not be willing or able to actually provide without the risk of suffering a significant penalty.

Instead, the dealer forces the consumer to either agree to a different interest rate or loan terms or return the car to the dealer. Of further concern, many dealers claim the right to immediately repossess the vehicle when the dealer decides to cancel the deal. The dealer also claims the right to charge rental fees, fees for wear and tear, and for fees incurred to repossess the vehicle.

What is the Consumer Financial Protection Bureau?

The dealer may also threaten to charge the consumer fees for use, wear and tear, or other items. In some cases, the dealer may threaten the consumer with prosecution for auto theft if the consumer does not immediately return the car to the dealer. There's no signing up. And no limit to how much is matched. We encourage an active and insightful conversation among our users.

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