The Consumer Financial Protection Bureau recently investigated auto lender Ally Financial amid concerns that the company regularly charged higher interest rates to non-white borrowers.
According to AutoNews, Ally has now agreed to cough up $98 million to settle the probe. Could this make things easier -- or at least more transparent -- for loan recipients down the line?
ABOUT AUTO LOANS & THE ALLY INVESTIGATION
When shoppers secure car loans through dealerships, dealers attempt to match those shoppers with low-interest loans, based on the shoppers' credit history and other factors. But like all middlemen, dealers need to make something in exchange for their work, and so, they charge what's know as the "dealer reserve" -- a markup of about 2.0 or 2.5 percentage points on the loan, which the dealers can pocket as profit.
That in itself is no big deal. We're all adults here, we all know that everyone needs to get a cut in order to stay in business. The same holds true no matter which broker a borrower might use.
These days, dealerships depend heavily on the dealer reserve. Margins on new cars are slimmer, and repair work, which used to be a sizable source of income, has disappeared as cars have become better-built and as lower-cost repair chains have lured customers away.
The problem is, the dealer reserve is applied at a dealership's discretion, which means that some customers receive preferential treatment -- not always for legitimate reasons. The CFPB examined roughly 800,000 Ally auto loans issued by 12,000 dealerships across the country. According to the Department of Justice, analysis of the data revealed that Ally "charged approximately 235,000 African-American, Hispanic and Asian/Pacific Islander borrowers higher interest rates than non-Hispanic white borrowers":
"[The DOJ and the CFPB] claim that Ally charged borrowers higher interest rates because of their race or national origin, and not because of the borrowers’ creditworthiness or other objective criteria related to borrower risk. The average victim paid between $200 and $300 extra during the term of the loan. The Equal Credit Opportunity Act (ECOA) prohibits such discrimination in all forms of lending, including auto lending."
African Americans paid the highest rates, coughing up roughly $300 more over the life of their loans than similarly qualified white borrowers. Hispanics and Asian/Pacific Islanders paid about $200 more.
WHAT DOES THIS MEAN?
Ally's case is a classic example of one guy (or gal, or company) exploiting a nominally fair business practice for financial gain -- though it bears mentioning that Ally has admitted to no wrongdoing. Of Ally's $98 million payout, $80 million will be used to reimburse consumers, and $18 million will serve as a fee.
What this means for lending as a whole, however, remains to be seen. The CFPB hasn't issued any new guidelines for auto lenders, but many see its investigation of Ally -- America's largest auto lender -- as a warning shot to the lending industry. In addition to the $98 million penalty, "the settlement requires Ally to improve its monitoring and compliance systems. The settlement allows Ally to experiment with different approaches toward lessening discrimination and requires it to regularly report to the department and the CFPB on the results of its efforts as well as discuss potential ways to improve results."
For now, the CFPB seems to be saying to Ally, "straighten up, or you're going to ruin it for everyone". Ultimately, the agency could push to replace the dealer reserve with a flat fee -- something that consumer watchdogs have long supported and that the auto industry has long resisted. Dealers claim that flat fees take away their power to negotiate -- a power that allows today's smart shoppers to whittle down their interest rates. (Less-smart shoppers? Well, they're out of luck.)
Our advice? As we mentioned last month, if you're in the market for a new car, we strongly advise you to shop for an auto loan before heading out to the showrooms. At the very least, you'll get an idea of the interest rate you can expect to pay, so you'll have something to compare with any offers that come from dealers. Otherwise, you're stuck with what dealers offer you, which might not be the best offer around.