Unless you have the cash to buy a car outright, you’re probably going to have to finance it – either with a private lender or through a car dealership.
Unfortunately, some car dealerships have a reputation for sticking their customers with predatory auto loans strapped with extremely high interest rates. People with lower credit scores are particularly vulnerable, though anyone not savvy about loan rates could be caught being charged more than they should. A February 2016 report from Experian Automotive notes that 1 in 5 current auto loans are either subprime or deep subprime auto loans. What more, auto loan delinquencies lasting more than 60 days are slightly up.
The good news is there are ways to protect yourself from being taken advantage of by a dealership when acquiring an auto loan.
Government Push to Stop Predatory Auto Loans
Predatory lending has long been an issue for consumers hoping to make big-ticket purchases such as homes or cars. There seems to always be a company awaiting an opportunity to take advantage of unsuspecting buyers.W
What is predatory lending? Basically, it’s unfair or fraudulent practices some lenders use during the loan origination process. This unsatisfactory form of lending reached its peak shortly before the financial crisis. But while most of the attention was focused on subprime mortgages, car buyers faced their own struggles with predatory lending.
In the months following the crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act was drafted and ultimately signed into law. Among the changes it demanded of Wall Street was acceptance of greater oversight. This oversight was to come from the Consumer Financial Protection Bureau (CFPB), which was formed to regulate consumer financial products and services.
Since getting its start, the bureau has cracked down on banks, credit card companies, credit bureaus and mortgage lenders. But auto dealerships had been exempt from the agency’s oversight.
The CFPB planned to change dealerships’ ability to evade the law by suing associated banks that finance predatory auto dealer loans. It also said in early 2013 that dealerships were using the “dealer markup” when they acted as middlemen between car buyers and auto lenders. In these cases, customers received higher rates despite their satisfactory credit histories. The bureau found this strategy was used disproportionately with minority buyers, who were charged higher interest rates than Caucasian borrowers with similar financial backgrounds.
In June 2015, the CFPB extended its supervision of auto financing from large banks and credit unions to "any nonbank auto finance company that makes, acquires or refinances 10,000 or more loans or leases a year." The bureau estimated that this will give it authority over roughly 90% of nonbank auto loans and leases. In November, the House of Representatives passed a bill to limit the CFPB's authority over auto lending, but thus far the bill has not gone any further.
4 Signs of a Predatory Auto Loan
Meantime, there are ways to protect yourself from becoming a victim of predatory lending. One of the first steps is recognizing the signs of predatory auto loans.
It’s not always easy for consumers to know when an auto dealer is attempting to issue a predatory loan. Here are a few signs to help you recognize when you could become a victim:
1. Being Told False Information Is OK
If the dealership encourages you to add false information to your loan application to help you secure an auto loan, this is a clear sign that you are working with a predatory lender.
2. Loans with Tons of Packages
If dealers try to sell you on overpriced add-on packages (credit life insurance, disability insurance, GAP insurance, theft deterrent packages, rust proofing, etc.), it’s likely attempting to inflate the vehicle cost and loan size.
3. “Bad Credit? No Problem!” Ads
Very often, predatory lenders will target individuals with poor credit by displaying “Bad credit? No problem!” ads. What they don’t share about these poor credit auto loans is that the rates offered are often considerably higher than what would normally be offered to borrowers with the same credit scores.
4. “Yo-Yo” Sales
If you are working with a lender that tries to convince you to enter into a conditional sale agreement rather than a final sale, this is a major sign of predatory lending. In this case, a dealer will send you home with the car, then call you back a few days later to say that your loan wasn’t approved.
It might ask you to renegotiate your loan and, to ensure you don’t try to back out of the deal, tell you your down payment is nonrefundable or your trade-in has already been sold.
How to Avoid Predatory Loans
If you are concerned about becoming a victim of predatory lending, it’s important to arm yourself with some ways to avoid predatory loans altogether:
1. Work with Reputable Financial Institutions
One of the best ways to ensure you don’t become a victim of predatory lending is to work with banks and credit unions that have good reputations for issuing auto loans in your area. Never take the dealership's loan without investigating other ways to pay for your car.
2. Research Reputable Dealerships
If you want to take advantage of cash-back bonuses or low-interest financing offers, then you might want to opt for a dealership over a financial institution. Before doing this, research consumer reviews online, check with the Better Business Bureau and even ask around town to find out the lending history of the dealership.
3. Understand Your Credit Score’s Value
One reason predatory lenders are able to take advantage of consumers is they know that many people don’t understand the value of their credit scores. Check your FICO credit score before visiting any lenders, then research your scores to learn the rates to which you are entitled. This will help you recognize when you’re being overcharged. Reading What Is a Good Credit Score? will help you evaluate what you find.
4. Recognize Your Personal Power
If you feel that you are being pressured to sign a contract that you’re not comfortable with, leave the dealership. This way, you won’t agree to a deal that could destroy you financially.
The Bottom Line
There’s nothing worse than realizing that you’ve been pressured to take a predatory auto loan that you’re now unable to back out of. Before signing your name on the dotted line of any auto loan contract, take time to think through your decision carefully and make sure you’re not being taken advantage of.