The U.S. Senate’s decision earlier this month to repeal guidance intended to stop car dealerships from charging higher interest rates on loans to minority buyers could cause lenders to shift away from a flat-fee model to one that critics have said can lead to discriminatory lending.
“The interest rate markup has an impact on minorities and women in all sorts of potential ways,” said John Van Alst, an attorney at the Boston-based National Consumer Law Center. “When dealers have that discretion, what happens is they wind up marking up some folks more than others. And that’s where we get this disparate impact.”
Not a formal law, the guidance issued by the CFPB in 2013 essentially provided recommendations for how creditors could avoid running afoul of the Equal Credit Opportunity Act.
Van Alst said the vast majority – up to 75 percent – of buyers finance their car purchases indirectly at dealerships as opposed to going directly to a lender to get a loan.
Dealers then contact lenders, including credit unions and banks, which tell the dealer they will finance a retail installment sales contract at a certain interest rate. That rate, the buy rate, is based on a person’s credit worthiness. The lender then tells the dealer they can mark up the loan a few extra percentage points, which the lender and car dealer split. While the lender sets a cap on that rate, the markup, the dealer has discretion over the markup rate as long as they don’t exceed the cap.
In a flat-fee model, the lender awards a fixed bonus to a dealership for making a sale.
Movement from Markup to Flat Fee
A 2016 study from the Ontario, Canada-based company CU Indirect concluded that credit unions had been moving away from markups to flat-fee models.
After the CFPB issued its original guidance, notable lenders Chicago-based BMO Harris Bank and North Carolina-based BB&T began moved to a single flat-fee models – BMO offered a 3 percentage-point flat fee on loans of 36 months and longer.
But after Mick Mulvaney became acting director of the CFPB, which signaled an easing regulatory stance at the consumer watchdog agency, BMO Harris and BB&T started to move away from flats earlier this year.
BMO Harris adjusted its plan to a three-tier model, offering its U.S. dealership clients a 1 percentage-point flat fee for loans of 36 months to 59 months, a 3 percentage-point flat for loans of 60 months to 72 months and a 5 percentage-point flat for loans of 73 months to 84 months.
BB&T didn’t disclose its new model, but BB&T Spokesperson Brian Davis told Automotive News that the company lefts its flat-fee model due to decreased volume. BB&T’s auto loan balance fell about 6 percent in the fourth quarter of 2017 compared to the fourth quarter of 2016.
As more lenders shift away from flat fees, Van Alst said that the market will likely follow “because this is how they compete at the dealerships.”
However, this does not appear to be true everywhere.
Digital Credit Union, a major auto lender in Southern New Hampshire and Massachusetts, indicated it will stick to a flat-fee model.
“DCU remains committed to the practice of fair lending and our policy is to make credit products available to all applicants who meet our business focus in a fair and consistent manner,” DCU Spokesperson John LaHair said in an email. “As part of this practice, our business model for indirect loans have always included flat fees for dealers. It is typical that within the credit union industry, that most if not all credit unions use a flat model.”
Higher Percentages on Larger Loans
While consumer advocates say a return to markups will lead to more discriminatory lending, dealers say a move to flats could adversely impact consumers because dealers would go to the lender with the highest flat rather than who has the best product to serve the customers’ need.
But according to a study from the Center for Responsible Lending in 2014 that spoke to almost 950 consumers that had purchased a car from a dealership in the prior six years, African-Americans and Latinos self-reported receiving interest rates higher than their white counterparts. They also reported financing larger loans that represented a higher percentage of their household income and having poorer credit than their white counterparts.
In the end, whether a lender chooses a markup or flat-fee model may come down to enforcement, as the CU Direct study said the main reason from the shift away from markups was due to rising enforcement from the CFPB.
