Most car dealers do not want consumers to know that they regularly mark-up the interest rate on auto loans. Many banks and finance companies will approve a credit application at a “buy rate” but permit the dealership to charge a higher “contract rate.” The bank will share the extra money that the consumer pays in interest. So, the consumer has a higher car payment, and the car dealership makes a higher profit. This is one of the reasons that car dealers are so eager to handle the financing when selling a car.
One nasty consequence of this industry practice is that women and minorities pay higher interest rates than white males. Dealerships have discretion on these markups, and the evidence shows that they frequently markup the interest rate in a discriminatory manner.
One study showed that car dealerships increased the interest rate for white women about 40% more than for white men. African Americans were hit with a markup that was double the markup charged to white men. Another study showed that Hispanics were nearly 50% more likely to have their interest rates marked up than white, non-Hispanics and that the mark-ups they paid were higher.
The Consumer Financial Protection Bureau does not have jurisdiction over car dealers, but it does have jurisdiction over the banks and finance companies whose policies permit interest rate discrimination by car dealerships. THe CFPB has recently made auto loan discrimination a priority. A recent United States Supreme Court case involving fair housing may make it easier to hold the banks and finance companies responsible for illegal discrimination.
One way to avoid this problem would be for banks and finance companies to scrap the “markup” system and to simply pay dealers a lump sum fee for each contract. It would also help if the markups were disclosed to consumers, most of whom have no idea that the interest rate is negotiable.
The best way that consumers can avoid overpaying for interest is to apply for credit directly with their own bank or credit union before going to the dealership. There are many types of auto dealer fraud that can be avoided if consumers shop as a cash buyer.