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Cheap auto loans often less cheap at dealerships

[Mar 14, 2011.]


The upswing in car sales may be coming with a hefty price tag. Statistics show the surge may be attributable to a precipitous increase in subprime lending last year. Meanwhile, car buyers may be unnecessarily digging deeper into their pockets as they miss out on the best financing deals and consumer debt rises.

The New York Times took a slightly sour line when, on Feb. 27, it looked at the recent resurgence in car sales. It accused Detroit of "crowing," and suggested that car makers' recent successes owed more to the increased availability of auto loans than anything the companies had done themselves.

The New York Times certainly seemed to have a point about newly relaxed lending criteria. It highlighted a recent study from CNW Marketing Research showing 859,000 new vehicles were sold to Americans with subprime credit in 2010, which was up 60 percent from the previous year. Ten days later, an Associated Press story in The Philadelphia Inquirer appeared to concur with the Times analysis when it noted:

As car buyers head back into dealerships after a two-year drought, they're being greeted by rock-bottom interest rates on auto loans, eye-popping lease deals, and a renewed willingness to lend to people with spotty credit.

Consumer debt on rise

Between publication of the Times and Inquirer reports, the Federal Reserve released its consumer credit data for January. According to MarketWatch, Americans increased their personal indebtedness by $5 billion that month. That was the equivalent of an annualized rate of 2.5 percent, and brought the total to $2.412 trillion.

Credit card debt actually fell that month, but that drop was more than made up for by the rise in "non-revolving" credit, which comprises fixed-term agreements such as auto loans, student loans, mobile home loans and so on. It leaped by a massive $9.3 billion (6.9 percent) in January after increasing by just $2.1 billion in December.

Most analysts think that auto loans make up the huge bulk of non-revolving credit.

Auto loans and rip-offs

Have you ever heard of "dealer reserves?" Don't worry if you haven't; few have. But you should be worried by them. That's because the Center for Responsible Lending (CRL), a national consumer advocacy group, claims that these cost American consumers $20 billion a year (no, that's not a typo: $20 billion each and every year) in inflated interest charges.

Here's how dealer reserves work. Once a consumer has chosen a car, the dealer goes online or phones around finance companies to find the best possible rate for that particular individual. But instead of picking the best deal for the buyer, the dealership chooses the one that offers it the best kickback, in the form of a dealer reserve.

It bumps up the low rate offered to whatever it thinks the buyer will pay. Sometimes the dealer shares the proceeds of this rip-off with the lender; other times it keeps the whole lot for itself. "Dealers rationalize this process as compensation for time spent finding financing, despite the fact that the average car buyer spends about 30 minutes with the finance department, which stands to gain more than $1,000 per hour for its service," according to the CRL. Check out the CRL's nifty graphic that describes the process.

A great way to avoid becoming a victim of this scam is to be armed with competitive quotes for auto loans before you set foot on your dealer's lot. These can, of course, give you a much stronger bargaining position.


About Author:

Peter Andrew has been writing about -- and for -- business for more than two decades. For the last couple of years, he has found himself increasingly specializing in the U.S. financial sector.

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