Beware the dealer reserve and other predatory lending practices

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Auto dealers remain free to engage in practices outlawed in the mortgage lending industry by financial reform. Image: Flickr/Shane's Stuff CC-BY-SA

A predatory lending practice in the mortgage industry outlawed by the financial reform bill escaped regulation in the auto lending industry. “Dealer reserve” is a legal practice similar to yield spread premiums; the practice of steering borrowers toward more expensive loans in exchange for a kickback. Although yield spread premiums are now illegal, dealer reserve isn’t. But informed car buyers can protect themselves from getting fleeced.

Dealer reserve, default and repossession

If you’re ready to shop around for an auto loan, thank the Center for Responsible Lending for bringing the practice of dealer reserve into the light of day. The CRL report, “Under the Hood: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses,” examines how auto dealers receive kickbacks from financing companies for selling customers loans with higher interest rates, even when they qualify for a lower rate. “Under the Hood” also describes a correlation between the dealer reserve and higher rates of default and repossession, particularly among subprime borrowers. Dealer reserve auto loans can cost borrowers an extra $1,200 to $1,700 over the life of the loan–possibly more if the borrower has bad credit. According to the CRL, the practice will cost car buyers $25.8 billion they didn’t have to pay.

Auto lenders pursue outlawed mortgage schemes

Dealer reserve is remarkably similar to yield spread premiums, commissions paid to mortgage brokers who would trick borrowers into higher interest rates. The Dodd-Frank financial reform bill put a end to yield spread premiums, but thanks to auto lending industry lobbyists, the new Consumer Financial Protection Agency is currently powerless to do anything about dealer reserve. Free from regulation, the auto lending industry is also adopting a practice similar to bundling bad mortgages into securities that were sold on Wall Street. Another report from the Center for Public Integrity describes the trend of bundling subprime auto loans into securities. By absolving auto lenders of the risks involved with making bad loans, subprime auto loan-backed securities are encouraging predatory lending by auto dealers.

Don’t be a yo-yo

The CPI report also mentions tricks auto dealers use to dupe borrowers into higher interest loans, such as the “yo-yo.” To pull the yo-yo con, a dealer will offer a bargain interest rate and let the borrower drive the car home. Later, the dealer will call to say financing fell through in hope that the buyer has become attached to the vehicle enough to accept a higher interest rate when they return it to the lot. To guard against the yo-yo and other auto dealer deceptions, check out the list below, courtesy of Forbes:

Stay focused. Fast-talking finance managers will try to confuse you, a mental state they call “in the ether.”

Negotiate hard, but concentrate on the bigger issues, not nickles and dimes

Avoid extras such as rust-proofing dealers use to pad the finance amount, especially “credit life” insurance, which may already be part of your homeowners insurance.

Read the fine print on a price advertised by the factory. Sometimes a dealer will try and keep the savings as a bonus, instead of passing it on to you.


Center for Responsible Lending


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