They might as well be twins. Both live in California, make more than $60,000 annually and have top credit scores. But one buyer has an annual interest rate of just 4.9% for the loan on their 2017 Chevrolet Trax. The other has an APR of 14.1%, meaning they’ll eventually pay an additional $7,000 in interest.
That’s anything but a rare exception, according to a new study by Consumer Reports. The non-profit took a look at nearly 900,000 car loans provided by 17 major lenders during 2019 and 2020, and what it discovered was that a sizable number of motorists wind up paying substantially more than they should when buying a vehicle.
While buyers with poor credit scores likely should expect to pay higher interest rates on an auto loan, CR found even buyers with great credit often wind up saddled with exorbitant rates that can run as high as 25% — or more.
A big business
“Sadly, this is all too common,” Ian Ayres, a lawyer and economist with the Yale Law School, told Consumer Reports. “I’ve seen a surprising number of consumers with excellent credit who are nonetheless written into subprime loans with high APRs.”
CR noted that this often pushes buyers beyond the point where they can comfortably afford to buy a vehicle and may trigger a high level of delinquencies and repossessions.
Auto lending is a big business. As of mid-2021, Americans owed $1.42 trillion on outstanding auto loans, according to the Federal Reserve Bank of New York. That was up from $730 billion in 2011, with the figure topping $1 trillion only in 2015.
Be prepared for battle
Automakers frequently promote zero interest loans, (at least, they did before the pandemic created a shortage of semiconductors and a serious lack of vehicle inventory in showrooms around the country). But only a fraction of new vehicle buyers actually qualify for those deals. So, most wind up paying interest on loans through banks, finance companies or “captive” finance subsidiaries of car companies like Ford.
Part of the problem is a lack of awareness. Many motorists simply take whatever loan package their dealer offers up. But F&I, or finance and insurance, is a major profit center for most retailers who are motivated to maximize what they can get out of a deal.
“The financing you get has a lot more to do with how prepared for battle you are when you walk onto the showroom floor than your financial history,” R.J. Cross, a tax and budget advocate for U.S. PIRG, told Consumer Reports.
In the rush to cut deals and complete loans, CR also found, dealers and lenders didn’t even both to verify the employment status and income of 96% of those taking out car loans.
Stick to your budget
Most consumers are advised to spend no more than 10% of their income on auto loan debt. But the CR study found that, in practice, a quarter of today’s car buyers exceed that limit. And that goes for motorists with good or bad credit.
The higher the figure, the more at-risk a buyer becomes, especially in times of economic uncertainty, as millions have discovered during the pandemic. Among all borrowers, 5% are now reported delinquent on their loans. And one in eight non-prime customers now have their vehicles repossessed, Consumer Reports noted.
Smart buyers should check with their own financial institution — and possibly other lenders — before locking down the purchase of a new vehicle, experts advise. But that doesn’t take dealers off the hook for selling customers on loans with exorbitant interest rates in a bid to make higher profits.
Borrower beware
“At a minimum, dealers should be required to disclose the different financing offers they get, and the interest rate markups they receive, so buyers can choose the best offer, or arrange for cheaper financing on their own,” said Chuck Bell, programs director for CR.
For the study, Consumer Reports looked at 858,000 loans that lenders bundled up for resale as asset-backed securities. While not “nationally representative,” the non-profit organization said the report nonetheless offers a good snapshot of the problem with auto financing.
Other studies issued in the last several years have highlighted still more concerns about auto loans — among other things pointing to higher rates charged women and people of color when compared to white males with comparable incomes and credit records.