For a long time, this blog has been warning car buyers and those who sign car financing agreements about some of the major risks of letting your local dealer set up your car loan. Now, we’re getting some backup from an established source: the Center for Responsible Lending is also getting the word out to new and used car customers that it’s critical to understand how dealer financing works.
The CRL deals with all sorts of consumer loans. You’ll find lots of stories on its web site about different kinds of lending, including mortgages, student loans and auto loans. You’ll also see news about impending legislation like Dodd-Frank and how that can affect lenders and borrowers. One thing that you’ll see is a prominent article entitled “Under the Hood” that looks at how dealer financing is often done. This article mostly focuses on something called “dealer reserve” or “dealer markup.”
As the CRL story points out, dealer reserve or dealer markup is a pretty simple idea: the dealer does the work of contacting third party lenders to see what they will offer for a consumer’s car loan. That makes it easy for the customer to walk in and get a car at the dealership without checking around themselves. However, as with almost all of this kind of outsourcing, you usually end up paying much more for these services than they are worth to you (think of it as paying up to $100 an hour for someone to pick up a phone and ask about interest rates). The trick is that, although the arrangement is simple, the cost is not often clear to customers: instead, it’s folded into the car financing agreement in terms of increased interest, which means you pay it, a little bit at a time, as a tiny part of your monthly car loan payments over the years. Some of the CRL’s numbers, though, are surprising. The center estimates that dealer markup costs Americans over 25 billion dollars during their car loan terms, with an average of $714 per loan attributed to this cost.
This kind of cost is common in all sorts of financing deals, including mortgages, where big-dollar items like mortgage insurance, title fees, and much more get combined into an “easy monthly payment.” In the case of car loans, though, consumer advocates don’t feel that the purchase process is complex enough to warrant a lot of increased fees or markups. Anyway, to avoid this problem, do the work yourself: get pre-qualified by third party lenders before you ever step onto the dealer’s lot, and you’ll be making your time and your money work for you. It’s all part of getting the low interest rates and cheap car financing that you deserve when it’s time to upgrade your wheels.