Rate Markups Cost Americans $25.8 Billion Over the Lives of Their Loans

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Costly Service

The average dealer rate markup is $714 per loan. Learn what that may mean to a consumer's pocketbook.

Cars are the most common nonfinancial assets held by Americans. For most families, owning a car is not merely a luxury, but a prerequisite to opportunity.Cars not only provide transportation, but also options for where to work and live, and how we all interact with our communities.As a result, both the affordability and sustainability of auto financing are critical to the lives of most American families.

This report examines one hidden practice in dealer-financed lending that affects the affordability and sustainability of millions of car loans. Specifically, the report takes a look at dealer rate markups, the hidden interest rate dealers add to a consumer's car loan once they sell the note to a third-party lender, and concludes that interest rate markups from dealerships lead to more expensive loans and higher odds for default and repossession for subprime borrowers.

The report also finds the following (click on each finding to learn more):

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.

  New Vehicles Used Vehicles Total Vehicles
2009 Total Rate Markup Volume $4.1 Billion $21.7 Billion $25.8 Billion
Average Rate Markup 2009 1.01% 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
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 that would be vulnerable targets for increased rate markups.

FINDING 3: Rate markups are a strong driver of default and repossession among subprime borrowers.

Markups have a strong association with 60-day delinquency and cumulative loss rates (what the lender has to write off due to repossessions) for finance companies that target low-FICO borrowers. These results occur for loans performing within the same macroeconomic environment, discounting the notion that the economy is the sole reason for recent loan defaults. Rate markup increases the odds of delinquency and cumulative loss for subprime borrowers by 12% and 33% respectively.

Odds ratios based on coefficients from linear regression models using auto ABS securities data. Changes in odds are based on an increase of one standard deviation of rate markup for finance companies (4.55%). Regression model for non-finance companies produced results that were not significant.

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