UNDER THE HOOD: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses. Delvin Davis and Joshua M. Frank.

Transcription

1 UNDER THE HOOD: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses Delvin Davis and Joshua M. Frank April 19,

2 Table of Contents Executive Summary...2 Introduction...7 Background Data and Methodology...9 Research Findings...10 Discussion and Recommendations...13 Appendices Endnotes Center for Responsible Lending 1

3 Executive Summary Automobiles are the most common nonfinancial assets held by American households.1 For most American households, car ownership is not a luxury, but a prerequisite to opportunity. Cars not only provide transportation, but also options for where to work and live, and how we interact with our community. As a result, both the affordability and sustainability of auto financing are central concerns for American families. A car purchase can be a complicated endeavor. Negotiations on the sales price, trade-in value, and financing are all separate transactions. Any of these transactions can have a significant influence on the vehicle s overall cost. Unfortunately, not all of these transactions are transparent to consumers. In particular, on loans made through the dealership, the dealer can markup the interest rate above what the consumer's credit would qualify for. This interest rate markup, also known as dealer reserve or dealer participation, is described by dealers as the way they are compensated for time spent putting a financing deal together. However, since consumers usually do not know what they can actually qualify for, the markup is often a hidden cost to the consumer. This report takes a look at markups, evaluates how they are used, and identifies their potential consequences. Our research concludes that interest rate markups from dealerships lead to more expensive loans and higher odds for default and repossession for subprime borrowers. Based on an analysis of automobile asset-backed securities (ABS), data from 25 auto finance companies representing a combined 1.7 million accounts at year-end 2009, and other information from industry sources, we find the following: Finding 1: Consumers who financed cars through a dealership will pay over $25.8 billion in interest rate markups over the lives of their loans. Analyzing 2009 auto industry data, the average rate markup was $714 per consumer with an average rate markup of 2.47 percentage points. Even though the number of vehicle sales declined by 20% from 2007 to 2009, total markup volume increased 24% during this period (from $20.8B to $25.8B) largely due to an increase in the level of rate markups on used vehicle sales. Figure 1: Total and Average U.S. Markup Volume 2009 New Vehicles Used Vehicles Total Vehicles 2009 Total Rate Markup Volume $4.1 Billion $21.7 Billion $25.8 Billion Average Rate Markup % 2.91% 2.47% Average Markup Per Loan 2009 $494 $780 $714 Dealer Gross Profit Per Retail Sale 2009 $1,301 $1,721 $1,461 Sources: Data derived from CNW Marketing Research (sales data for dealer financed purchases, excluding leases), 2010 National Auto Finance Automotive Survey (dealer markup data), and YTD 2009 NADA Average Dealership Profile (gross dealer profit). Average markup figures assume a rate markup occurs on every dealer-financed sale, leading to more conservative averages. 2 UNDER THE HOOD: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses

4 Finding 2: Dealers tend to mark up interest rates more for borrowers with weaker credit. As shown in the chart below, loans made by subprime finance companies have higher rate markups, and rate markups also increase with lower borrower credit scores. In addition, larger rate markups occur on loans with longer maturities, loans for used vehicles, and when smaller amounts are financed. These findings suggest that dealers may use certain borrower or loan characteristics as a way to identify people who would be vulnerable targets for increased rate markups. Figure 2: Change in Amount of Rate Markup Given Changes in Loan Conditions 6.00% 5.00% 5.04% Additional APR due to Rate Markup (in percentage points) 4.00% 3.00% 2.00% 1.00% 2.23% 2.84% 3.04% 3.07% 3.44% 0.00% Smaller Amount Financed (-$3,300) Higher % of Used Sales in Portfolio (+30%) No Markup Cap Present Longer Loan Terms (+4 months) Lower Borrower FICO Score (-47 points) Loan Made by Subprime Finance Co. Figures are based on results from regression models using auto ABS data. The change in each category is assuming the increase of one standard deviation in the independent variable. Note that the markup increase of each variable does not have a cumulative effect if multiple conditions exist on one loan. Lenders may use self-imposed markup caps to control pricing. However, finance companies that lend more to subprime borrowers are not likely to have rate markup caps at all. Still, even the typical markup cap can still allow for nearly $1,700 in extra interest payments over the life of a typical new car loan. Center for Responsible Lending 3

5 APPENDIX 5: Frequency Histogram of Estimated Rate Markup Frequency Estimated Rate Markup (mean-centered) APPENDIX 6: Data and Methodology Limitations Working with aggregated pool-level data instead of loan-level data presents several challenges in analysis. Although we do not anticipate any issues with data distribution in any particular pool, to some degree we do have to use assumptions of the variance within each pool. Consequently, we are forced to use mean values of different variables drawn from each pool, which is a broad representation of what the data is on the loan level. Using pool level data also does not allow for a large sample size, which would give more flexibility for a multiple regression analysis. A more robust dataset would also help protect against any issues of multicollinearity between certain variables. Ultimately, the challenges of working with data only reported in the aggregate illustrates the need for more readily available auto loan data as a matter of public policy. Loan level data availability, as like what we have with the Home Mortgage Disclosure Act, adds a layer of transparency necessary to help preserve fairness and consumer protection. Center for Responsible Lending 21

6 Endnotes 1 Federal Reserve Board, Changes in U.S. Family Finances from : Evidence from the Survey of Consumer Finances, Feb Approximately 87.0% of families in the U.S. owned at least one vehicle in CNW Marketing Research, Personal Use Repossessions of Total Sales, (Document 243). 3 Public Policy Polling survey administered Jan 15-18, Findings state that 79% of 494 surveyed respondents, all located in two North Carolina counties, were not aware that dealers have the ability to markup interest rates. 4 Most Consumers Do Not Know the APR on Their Auto Loans, Subprime Auto Finance News, Sep 16, According to findings from a 2008 Capital One Financial Corp survey, 61% of consumers with auto loans do not know the interest rate they are paying. 5 David N. Robertson, Seven Deadly Sins of F&I, Association of F&I Professionals, Feb 5, seven-deadly-sins.htm 6 Mark A. Cohen, Imperfect Competition in Auto Lending: Subjective Markup, Racial Disparity, and Class Action Litigation, Vanderbilt University, Dec Quote by Jesse Toprak, Executive Director of Industry Analysis at Edmunds.com. Article by Justina Ly, Pressure Cooker, F&I Management and Technology Magazine, Jun F&I Management and Technology Magazine Benchmarking Study, Oct The median profit per retail unit for new and used sales combined was $ See Appendix 2 for further details on loan packing, yo-yo deals and rolling negative equity. 10 Title Insurance Cost and Competition, Testimony of J. Robert Hunter, Consumer Federation of America Director of Insurance, Before the House Committee on Financial Services Subcommittee on Housing and Community Opportunity. Apr 26, David N. Robertson, Seven Deadly Sins of F&I, Association of F&I Professionals, Feb 5, seven-deadly-sins.htm 12 Public Policy Polling survey administered Jan 15-18, Findings state that 79% of 494 surveyed respondents, all located in two North Carolina counties, were not aware that dealers have the ability to markup interest rates. 13 Most Consumers Do Not Know the APR on Their Auto Loans, Subprime Auto Finance News, Sep 16, According to findings from a 2008 Capital One Financial Corp survey, 61% of consumers with auto loans do not know the interest rate they are paying. 14 Delvin Davis and Joshua M. Frank, Car Trouble: Predatory Auto Loans Burden North Carolina Consumers, Center for Responsible Lending, Apr 2009, p4. 15 CNW Marketing Research, Sales, Values Historic Data on Auto Market, (Document 270). 16 National Automotive Finance Association 2010 Automotive Financing Survey. Data compiled by BenchMark Consulting International. 17 CNW Marketing Research, Time Spent at a Dealership (Document 2). Figures used are from 2008, and only includes consumers who actually purchase a vehicle. 18 William C. Apgar and Allegra Calder, The Dual Mortgage Market: The Persistence of Discrimination in Mortgage Lending, published in The Geography of Opportunity: Race and Housing Choice in Metropolitan America, Jessica Jones, Default Rates on Auto Loans, Stephen F. Austin State University Economics Department, Erkan Erturk and Joseph F. Sheidan, Investigating U.S. Auto Loan Credit Performance During Economic Downturns, , Standard & Poors, Dec 15, CNW Marketing Research, Sales, Values Historic Data on Auto Market, (Document 270). 22 UNDER THE HOOD: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses

7 22 CNW Marketing Research, Profit Margins by Department - National, Personal Use Vehicles Only, (Document 925). Figures are for June Mark A. Cohen, Imperfect Competition in Auto Lending: Subjective Markup, Racial Disparity, and Class Action Litigation, Vanderbilt University, Dec Mark A. Cohen, Imperfect Competition in Auto Lending: Subjective Markup, Racial Disparity, and Class Action Litigation, Vanderbilt University, Dec CNW Marketing Research, Personal Use Repossessions of Total Sales, (Document 243). 26 Federal Reserve System Federal Register, Rules and Regulations, Vol 75, No 185, Sept 24, 2010, pp Title Insurance Cost and Competition, Testimony of J. Robert Hunter, Consumer Federation of America Director of Insurance, Before the House Committee on Financial Services Subcommittee on Housing and Community Opportunity. Apr 26, 2006, p GAP insurance refers to Guaranteed Automobile Protection. If a car with negative equity is stolen or wrecked to the point of total loss, conventional insurance may only cover the value of the car at the time of the incident. Consumers would still be left with the remaining balance on the car loan. GAP insurance would reimburse the consumer up to a certain amount in order to cover the deficit. 29 Quote by Phil Reed, editor at Edmunds.com. Interview by Lucy Lazarony, Beware of the extended warranty add-on, Bankrate.com, Jan 11, Justina Ly, Pressure Cooker, F&I Management and Technology Magazine, Jun John D. Stoll, Cut from GM, GMAC Uses New Strength To Expand, Wall Street Journal, Sep 24, GMAC created a goal to boost revenue by giving cash incentives to dealers who use an increasing amount of GMAC add-on products, including car loans, service contracts and insurance. Likewise, many GMAC loan officers compensation was changed from a salary to commission-based pay. 32 Attorney General Hardy Myers Announces Settlement With Salem Car Dealership Ending Sales Practices of Packing, Oregon Department of Justice press release, Aug 20, Delvin Davis and Joshua M. Frank, Car Trouble: Predatory Auto Loans Burden North Carolina Consumers, Center for Responsible Lending, April 2009, p5. A quarter of all consumers with incomes $25,000 or less have experienced a yo-yo, translating to a 5 percentage point increase in their interest rate. 34 CNW Marketing Research, Equity Impact on Acquiring a New Vehicle, (Document 200). 35 Richard Apicella and George Halloran, The Rising Repossession Tide, Benchmark Consulting International, Apr Dana Howard, Drivers Left on the Hook After Car Dealers Fail to Pay Off Trade-Ins, ABC News 10-KXTV, Sacramento, CA, Srabana Dasgupta, S. Siddarth and Jorge Silva-Risso, To Lease or Buy? A Structural Model of a Consumer's Vehicle and Contract Choice Decisions, American Marketing Association, Journal of Marketing Research, Vol XLIV, Aug Center for Responsible Lending 23

8 About the Center for Responsible Lending The Center for Responsible Lending is a nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL is affiliated with Self-Help, one of the nation s largest community development financial institutions. Visit our website at North Carolina 302 West Main Street Durham, NC Ph (919) Fax (919) California 1330 Broadway Suite 604 Oakland, CA Ph (510) Fax (510) District of Columbia th Street NW Suite 500 Washington, DC Ph (202) Fax (202) Copyright 2011 by Center for Responsible Lending