Government regulators are moving toward potential action against auto lenders who may be guilty of discriminatory practices.
Senior officials within the U.S. Justice Department have reportedly stated that federal prosecutors will be teaming with the U.S. Consumer Financial Protection Bureau to investigate potential mistreatment of certain customers. Among the accusations is that auto dealers, as is their discretionary right, have been disproportionately marking up interest rates on loans arranged through lenders for minority and female borrowers. According to a Washington Post report, the trend has reached the point where borrowers have been barraged by unmanageable fees and have begun to take action by questioning the practice - specifically asking whether it violates fair-lending rules.
The Wall Street Journal recently cited U.S. officials who confirmed that practices exhibited within the auto financing market offer enough evidence to warrant a wide-ranging probe of the industry. During a subsequent government forum, CFPB and Justice Department representatives said they were aggressively proceeding with "a number of joint investigations."
Legal lending versus fair lending
Essentially, dealerships are believed to be exploiting a loophole within the lending framework, but in doing so are victimizing an inordinate number of minority borrowers. Investigators have and will continue to look into the interest rates attached to loans provided by banks but set up by dealerships, specifically comparing the rates charged to white borrowers with those assigned to loans for black and Latino borrowers.
Few details have yet emerged regarding the investigations, but CFPB fair-lending official Patrick Ficklin did reveal that, based on early findings, the average interest rate charged to minority borrowers was 0.2 to 0.3 percent higher than those offered to white customers. Without elaborating much further, Ficklin simply said that the disparity displayed is of concern to the CFPB, per Wall Street Journal's report.
The difference between tenths of a percentage point in interest rates may not seem significant at first glance, but over the life of a loan the costs can differ by tens of thousands of dollars. Ficklin provided the example of a five-year, $26,500 loan. With a 4.8 percent interest rate attached instead of 4.5 percent, the borrower would pay approximately $215 more in monthly fees, amounting to nearly an additional $3,000 per year.
"Our initial analysis thus far raises serious concerns about discrimination in the field of indirect auto lending, which is causing millions of dollars in harm to consumers," said CFPB Director Richard Cordray.
Disclosure discussions and dangerous precedents
As one of his suggestions for reversing the trend, Cordray proposed that lenders be required to disclose the exact interest rates borrowers will pay both immediately and over the life of the loan, specifically informing the customer whether they would qualify for a lower rate not inflated by extra charges in interest applied by the dealer as a sort of finder's fee. CFPB officials have also suggested alternative pricing models that would allow individual dealerships to maintain comparable profit levels without employing such discriminatory practices. By either charging a flat fee or a fixed percentage on the loan - or some hybrid therein - compensation for the dealer would be guaranteed and tied to the length of the contract.
Of course, proposal and enforcement are two very different issues. The concepts being floated by the CFPB are not particularly popular ones. Auto dealers are currently exempt from most forms of CFPB oversight based on a provision contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Cordray and other bureau officials have assured that they have the authority to oversee auto-lending practices, but some voices in Washington have expressed concerns regarding the precedent being set. By delving into the discrimination issue without formally adhering to the steps of the process, the CFPB runs the risk of exposing other pieces of Dodd-Frank to vulnerability. It's an important bit of context to understand, given the polarizing nature of many parts of the Dodd-Frank legislation that apply uniformly to lenders and businesses associated with the housing finance market.
In pushing to standardize interest-rate changes on auto loans, the CFPB would essentially limit the latitude currently afforded to dealerships who facilitate the process of providing financing options from a bank or credit union to a customer. It underscores an important aspect of the auto lending industry that has been the subject of increased scrutiny, as many analysts wonder aloud whether the same tendencies exhibited by the pre-recession housing market are being reflected. In placing greater restrictions on the loans that could be offered, government regulations forced housing industry lenders to place a renewed emphasis on risk assessment and loss mitigation, and while some prospective borrowers may have been boxed out of the market, the landscape improved overall.
If the same ultimately holds true for the auto lending industry, then an investigation into such discriminatory practices is important for a wide range of reasons.