Car dealers like to brag about their relationships with multiple banks and finance companies, and they often imply that these connections help consumers get low interest rates. But, many consumers would be surprised to learn that car dealers frequently mark-up the interest rates. In many deals, the dealership makes more money by marking up the interest rate than they profit from the sale itself.
Most car purchases are financed at the dealership. Buyers give credit information to the dealer, who submits it banks or finance companies. While a consumer might think that the dealership will submit the applications to the creditors offering the best rates, many dealerships will instead steer customers to the lendors that will kick back the most money to the dealership. For example, a lender might approve an application at a rate of 6% but permit the dealership to mark-up the interest rate to 8.5%. For a 60-month loan of $20,000, the consumer will pay about $1,300 more in interest, which comes to an extra $22 a month. The dealership might profit by about $650 by making the consumer pay more.
Most consumers don’t realize that interest rates are negotiable, and dealerships work hard to keep it that way. The finance managers at many dealerships give mislead consumers into believing that they are working to get the consumer the best available rate. If a consumer questions the interest rate, the finance manager may blame the consumer’s credit or market conditions. And, these finance managers have an incentive to make the consumer pay more, because most of them earn a commission on the extra profit the dealership makes by increasing the interest rate. While we do not dispute that dealerships are entitled to earn a reasonable profit, we believe that it is a fraudulent and unfair practice for dealerships to mislead consumers. A dealership should not tell a consumer that they are working to get the consumer the best possible rate when they are profiting by charging a rate higher than the amount approved by a bank or finance company.
The problem of dealership markups is compounded by the fact that, in many instances, minorities are charged higher rates than whites. Some private lawsuits and, more recently, an action by the Consumer Financial Protection Bureau, have charged that minority groups such as African-Americans are charged higher interest rates than whites. Research suggests that car dealers may feel that they can better take advantage of minority groups and are therefore more aggressive with their pricing. This discriminatory pricing is a violation of the Equal Credit Opportunity Act, which prohibits charging higher interest rates on the basis of race, ethnicity, age, or gender.
Our advice: consumers should shop for interest rates and apply for credit approval directly with a bank or credit union before going to a car dealership. After obtaining credit approval, select a car and tell the dealership that outside financing has already been approved. After negotiating a fair cash price for the car, let the dealership know that you are approved for financing elsewhere and ask if they can beat your rate.