A Much Bigger Issue With Auto Financing

I recently read a local news article with the headline, “Toyota Must Pay $22 Million for Charging Minorities Higher Interest Rates”. The article went on to explain that the U.S. Justice Department and Consumer Financial Protection Bureau reached a settlement with Toyota under which Toyota agreed to pay out the large sum to resolve allegations that it “discriminated against black and Asian/Pacific Island borrowers in auto lending.”

The article also stated: “The agencies contended that the average African-American victim was obligated to pay over $200 more during the term of the loan, and the average Asian/Pacific Islander victim was obligated to pay over $100 more, because of discrimination.”

While I am definitely an advocate of equal opportunity and believe that one’s skin color or racial origin should in no way shape or form have an effect on the interest rate they would pay on a loan, the purpose of my article actually stems from the local news article’s second paragraph:

“Through the settlement, filed in Los Angeles federal court, Toyota agreed to limit the discretion of its dealers to charge interest rate markups on Toyota loans. The company also agreed that it will not increase the interest rates it quotes to car dealers in order to fund additional non-discretionary dealer compensation.”

I’ll explain that a little better in normal, understandable words in a second, but first, let’s also take a look at two additional paragraphs from later in the article which I’ve combined into one here:

“Toyota’s business practice, like most other major auto lenders, allows car dealers discretion to vary a loan’s interest rate from the price Toyota initially sets based on the borrower’s objective credit-related factors. Dealers receive greater payments from Toyota on loans that include a higher interest rate markup.”

So, what does all of this mean and why is this even more important than the settlement about racial discrimination in auto loan interests rates? Well, what this amounts to is the fact that Toyota, like many other auto manufacturers, provides a company-sponsored financing option for customers through their dealers. I’m sure you already knew that, right? What you probably don’t know is that Toyota’s financing arm provides a baseline interest rate that they want as compensation for making a loan to customers, but then, allows the dealer to add points to that interest rate, essentially raising the rate, at their discretion, and in fact, on top of that, provides dealers with incentives to charge customers higher interest rates.

Do you see why this is an even bigger deal than the race issue in this story? If not, go ahead and go back and read the previous paragraph again.

I am willing to bet that when you purchased your last car at a dealership and sat down with the dealership’s finance guy, when you were presented with an interest rate and a contract that showed all of those thousands of dollars in interest you were paying on your auto loan, you thought your rate was based solely on your credit score. I bet you had no idea your interest rate included additional points added by the dealer based on their perception of you, or any other factor the dealership decided to take into consideration.

Do you see what this means for the auto finance customer? If the dealership has hit hard financial times and needs more profit, they can charge you more in interest on your loan. Does the dealership owner need to put in a new pool at home so his kids stop bitching at him about being bored all summer? Well, then he can charge higher interest on your car loan to pull in some extra cash. And, of course, as the article reports, it was this discretion of adding additional points to the auto loan interest rate that gave the humans writing and approving the loan paperwork the ability to charge you more interest if your skin was a certain color, or if you had a certain last name or eye shape, or really, add additional interest if anything about you led them to feel you would have more difficulty paying back the loan.

Would I have paid a higher interest rate had I walked into the dealership in flip-flops, board shorts and a tank top instead of a suit, regardless of my credit score? Would I have paid more in interest based on whether I was sold the car by the salesman who was not my same race, or by the salesman who was my same race? Would I have paid more in interest at one dealership as opposed to another based on the color of my skin or the ethnicity of my last name? What this article and this settlement are saying is….yes.

I know the car buying process can be long and stressful, especially if you take the time to get the best price, look at a lot of different options, makes and models, but what this article tells me is that not only do we need to consider a car’s features, options, color, longevity, gas mileage, and repair and service costs, but we must also ask some very important questions of the dealership when it comes to financing as well. Ask the dealership what the rate from the manufacturer is and what their mark-up of that interest rate is, and be sure to ask them why there is a mark-up. Know your credit score BEFORE having the dealership run your credit and contrast and compare the interest rate that your credit score is earning not only with different manufacturers, but also different dealerships. Look into whether or not you can secure your own financing through your own bank so your interest rate is not at the whim of the manufacturer, dealer, finance guy, or salesman.

While it is nice to see that Toyota is trying to take steps to stop discrimination and dealer incentivized rate increases in the lending process, the fact remains that as long as the major auto manufacturers continue these types of captive loan practices, consumers have a very real prospect of paying higher interest rates for reasons that are not disclosed to them.

I am hoping that after reading this article, the next time you finance a car, you’ll do a little digging on the reason behind your interest rate before signing that contract.

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